Are Budget Rigidities a Source of Fiscal Distress and a Constraint for Fiscal Consolidation?

87 Pages Posted: 7 Aug 2019

See all articles by Ercio Munoz

Ercio Munoz

City University of New York (CUNY), The Graduate Center, Department of Economics

Eduardo Olaberria

World Bank

Date Written: August 6, 2019

Abstract

This paper studies whether budget rigidities affect the probability of countries getting into fiscal distress and reduce the likelihood of governments performing fiscal adjustments. Budget rigidities are constraints that limit the ability of the government to change the size and structure of the public budget in the short term. Budget rigidities stem from different institutional arrangements and therefore can take different forms. To build an indicator of rigid spending that is comparable across a large set of countries, this paper employs a simple definition based on budget components that are naturally inflexible: the sum of public wages, pensions, and debt service. It decomposes this measure into a structural component and a nonstructural component. Then, the paper applies a linear probability model to a panel of 182 advanced and developing countries. A key finding is that relatively high shares of rigid (observed) components of public spending contribute to countries getting into fiscal distress and are a constraint for fiscal consolidation. The paper finds evidence that a relatively high share of nonstructural rigid spending contributes to the probability of fiscal distress and reduces the probability of fiscal consolidation. Moreover, the effect of rigid expenditure seems to be more relevant for economies with high inequality, governments with lower margins of majority, and countries with lower institutional quality. In addition, when looking at the composition of the measure of rigid expenditure, there is also some evidence that higher expenditure on pensions reduces the probability of fiscal adjustment more robustly than higher expenditure on wages.

Keywords: Public Sector Economics, Public Finance Decentralization and Poverty Reduction, Macro-Fiscal Policy, Economic Adjustment and Lending, Judicial System Reform, Inflation, Public Financial Management, Youth and Governance, Social Analysis, Government Policies, Quality of Life & Leisure, National Governance

Suggested Citation

Munoz, Ercio and Olaberria, Eduardo, Are Budget Rigidities a Source of Fiscal Distress and a Constraint for Fiscal Consolidation? (August 6, 2019). World Bank Policy Research Working Paper No. 8957. Available at SSRN: https://ssrn.com/abstract=3433463

Ercio Munoz (Contact Author)

City University of New York (CUNY), The Graduate Center, Department of Economics ( email )

365 Fifth Avenue, 5th Floor
New York, NY 10016
United States

Eduardo Olaberria

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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