Why Do Countries Have Fiscal Rules?

Abstract

Reforms of fiscal institutions and fiscal rules are motivated by several objectives: strengthening fiscal solvency and sustainability, contributing to macroeconomic stabilization, and making fiscal policy more resilient to government corruption and private-sector lobby. These objectives are shared by most fiscal policy makers worldwide. So why do some countries adopt fiscal rules while others do not? This question boils down to identifying the conditions under which some countries decide to adopt fiscal rules and maintain them over time. In particular, which political and institutional conditions are behind the decision of policy makers to tie their own hands? Are fiscal rules more likely to be associated to particular monetary and exchange-rate regimes, or to deeper financial market development and more openness? Is it more likely for countries to keep fiscal rules in place when they exhibit stronger fiscal policy performance –or does the opposite hold true? Are richer countries more likely to adopt fiscal rules? These are the empirical questions addressed by this paper. There are very few studies that identify institutional and economic variables explaining why countries adopt and maintain fiscal rules. This paper extends previous knowledge in two dimensions. First, the model used here is much broader in its specification, focusing on five categories of potential determinants for the choice of de jure fiscal rules, addressing the particular questions raised above. Second, the sample size is larger, comprising an annual-data panel sample of 94 countries (of which 35 have adopted fiscal rules) and spanning 34 years (1975-2008). The empirical estimation is performed using models selected after a detailed discussion of econometric issues relevant to this choice. The base-line results are subject to several robustness checks, presenting alternative results for different time samples, country samples, and categories of fiscal rules.