Can Fiscal Rules Help Reduce Macroeconomic Volatility in the Latin America and Caribbean Region?
The debate on fiscal policy in Europe centers on how to let automatic stabilizers work while achieving fiscal consolidation. There is significant agreement on the importance of using fiscal policy as a counter-cyclical instrument, as monetary polic...
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| Format: | Policy Research Working Paper |
| Language: | English en_US |
| Published: |
World Bank, Washington, DC
2014
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| Online Access: | http://documents.worldbank.org/curated/en/2003/06/2438506/can-fiscal-rules-help-reduce-macroeconomic-volatility-latin-america-caribbean-region http://hdl.handle.net/10986/18172 |
| Summary: | The debate on fiscal policy in Europe
centers on how to let automatic stabilizers work while
achieving fiscal consolidation. There is significant
agreement on the importance of using fiscal policy as a
counter-cyclical instrument, as monetary policy can no
longer play this role. In contrast, most of the discussion
on fiscal policy in Latin America and the Carribean region
(LAC) deals just on solvency issues, largely ignoring the
effects of the economic cycle. This is surprising as LAC
economies are much more volatile than their European
counterparts and have been generally applying pro-cyclical
fiscal policies that exacerbate volatility. Some analysts
and policymakers appear to think that counter-cyclical
fiscal policies are a luxury that only industrial countries
can indulge in or, at least, that LAC countries (with the
exception of Chile) that have successfully put in place a
counter-cyclical fiscal policy need to deal first with
pressing adjustment and solvency issues before they attempt
to reduce the highly pro-cyclical character of their fiscal
policies. The author argues that this is a major mistake
because the costs of pro-cyclical fiscal policies in LAC are
huge in growth and welfare terms, especially for the poor,
and because pro-cyclical policies and rules tend to develop
a deficit bias, thus ending up being nonsustainable and
noncredible. Perry illustrates both propositions. He then
examines the causes of the pro-cyclicality of fiscal
policies in LAC and discusses how well-designed fiscal rules
may help to deal with the political economy and credibility
factors behind pro-cyclicality. He also examines conflicts
between flexibility and credibility in rules, showing how a
good design can both facilitate the operation of automatic
stabilizers while at the same time supporting solvency goals
and enhancing credibility. Perry evaluates the experience
with different fiscal rules and institutions in LAC to see
the extent they have helped or can help to achieve the twin
goals of avoiding deficit and pro-cyclical biases. |
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