Institutions must be strengthened, the preparation of budget forecasts must be improved to avoid optimism biases and a political commitment must be assumed.
Fiscal rules have become a policy tool to promote the sustainability of public finances so frequently used that more than one hundred countries in the world are already applying them, and in our country it has been up to the first term of President Luis Abinader to submit the draft to Congress. Fiscal Responsibility Act and to push for its approval, and it will be up to his second term to begin implementing it, regardless of the difference of criteria that may exist regarding the level of rigor of its content.
But since it is such an important tool for fiscal sustainability, it is to be expected that future governments will strengthen it by enforcing it.
But it turns out that the adoption of fiscal rules alone does not guarantee an improvement in fiscal performance. To achieve this, it is key to ensure compliance, and this is not always achieved.
A study conducted in fourteen Latin American and Caribbean countries by IDB economists Martín Ardanaz, Oscar Valencia and Carolina Ulloa Suárez found that compliance rates with fiscal rules had fluctuated between periods, exceeding 80% in some and falling below 20% on average in others.
What are the main factors influencing compliance?
First, there is the change in macroeconomic conditions. The researchers found an asymmetric response of compliance to the state of the economy. While compliance declines in bad times, it does not improve sufficiently in good times.
When countries experience modest GDP declines, typically around 1% or less, policymakers tend to adhere to fiscal rules with a probability ranging from 69% to 72% in terms of compliance.
In contrast, when GDP shocks become more severe, with negative growth rates exceeding 10%, the probability of compliance decreases significantly, often falling to 30% or even more.
Second, there are the forecasts of policymakers: If they are too optimistic, they undermine compliance during the budget cycle: “The probability of ex post compliance with the fiscal rule is lower when policymakers overestimate GDP growth ex ante. In contrast, compliance with fiscal rules tends to be at its highest when fiscal authorities underestimate economic growth.”.
Third, there is institutional quality: strong institutions support compliance, and the opposite is true for weak institutions. The researchers’ results highlight a notable disparity between countries with weak institutions and countries with strong institutions, which show a probability of compliance that is twice as high as in countries with weak institutions.
Finally, there is the design of fiscal policies. The researchers concluded that the introduction of formal sanctioning procedures does not play a significant role in compliance with fiscal rules and that the presence of a fiscal council in charge of supervising fiscal rules and/or targets does not seem to significantly increase the likelihood of compliance either, a result that contrasts with findings in other regions, especially in OECD countries.
The recommendations are self-explanatory: take measures to strengthen institutions and thus increase commitment to fiscal rules, improve the preparation of budget forecasts to avoid optimism biases, and make a strong political commitment to fiscal rules, since without this type of support, efforts to increase supervision and apply sanctions may be insufficient to ensure effective compliance with fiscal rules.
