Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / The Quiet Power of Fiscal Rules
Transcript
- Lucas: So there's this quiet piece of machinery in fiscal policy that almost never makes headlines, but it shapes how entire countries borrow and spend. I'm talking about fiscal rules—legal or constitutional limits on deficits, debt, or spending. Luna: Right, the kind of thing that sounds dry but actually causes real fights when governments hit the ceiling. Lucas: Exactly. Take Germany. In 2009, they added a 'debt brake' to their constitution. It says the federal government's structural deficit—that's the deficit adjusted for the economic cycle—cannot exceed 0.35% of GDP. The states are banned from running structural deficits entirely. Luna: 0.35% is tight. How did that come about? Was it a response to the 2008 crisis? Lucas: Partly. Germany had already breached the Maastricht Treaty's 3% deficit limit a few years earlier. There was political pressure to lock in discipline. The debt brake passed with a two-thirds majority in both houses of parliament. It took effect fully in 2016, with a transition period. Luna: And has it worked? I mean, Germany's debt to gdp ratio came down a lot after 2010. Lucas: It did. By 2019, Germany's debt ratio was below 60% of GDP—one of the lowest in the Eurozone. Then COVID hit, and they suspended the rule. That's the thing with fiscal rules—they tend to get suspended during emergencies. Luna: So the rule only binds in good times. That sounds like a feature, not a bug, if you want flexibility. Lucas: Exactly. The German constitution allows suspension by a majority vote during natural disasters or severe recessions. They used it for COVID, and again for the energy crisis in 2022. But the rule came back into force in 2024, and it's already causing friction. Luna: Over the current budget, I assume. Germany's coalition has been fighting about spending for months. Lucas: Yes. The debt brake requires the government to keep the structural deficit under that 0.35% cap. But after years of crisis spending, the baseline is higher. There's a debate about whether to reform the rule to allow more investment. The finance minister wants to stick to the rule; the economy minister wants to loosen it. Luna: So the rule is doing exactly what it's supposed to—forcing a political conversation about priorities. Lucas: That's one way to see it. But it also constrains things like infrastructure spending, which might have long-term benefits. Critics say the rule is too rigid for a modern economy. Supporters say it's the only thing preventing politicians from borrowing recklessly. Luna: Let's talk about another famous case—Switzerland. They have a debt brake too, but it works differently, right? Lucas: Right. Switzerland introduced its debt brake in 2003. It's also constitutional. But instead of a fixed deficit limit, it ties spending to cyclically adjusted revenue. If revenue grows faster than trend, the surplus goes into an amortization account. If revenue falls short, the deficit must be compensated in future years. Luna: So it's a kind of pay as you go rule, but with a buffer account. Lucas: Exactly. And it's been remarkably effective. From 2005 to 2019, Switzerland ran surpluses most years and its debt to gdp fell from about 55% to under 25%. That's a huge deleveraging for a developed country. Luna: They also suspended it during COVID, I assume. Lucas: They did, but with a twist. The rule allows for exceptional circumstances, but any deficit incurred must be repaid within six years. So the Swiss parliament approved a COVID package, but it's being paid back through future spending cuts and tax increases. That's the discipline built in. Luna: That's a lot more binding than Germany's rule, which just resets after suspension. Lucas: Exactly. Now let's go to a completely different context—Chile. In the early 2000s, they adopted a structural balance rule. It targets a structural surplus of 1% of GDP, later adjusted to 0.5%. The idea is to save copper revenues during boom times and spend them during busts. Luna: Since copper is Chile's main export, that makes a lot of sense. Avoid the resource curse. Lucas: Right. The rule is enforced by two independent expert panels—one estimates the long-term price of copper, the other calculates potential GDP. That determines how much the government can spend. It's been credited with reducing volatility and maintaining fiscal credibility. Luna: But Chile had social unrest in 2019, then COVID, and they increased spending a lot. Did the rule survive? Lucas: It was temporarily suspended. In 2020, they allowed a deficit of over 7% of GDP. But the rule provided a framework: the government had to present a plan to return to the structural target over a specific horizon. They've been gradually tightening since 2022. Luna: So the rule acts like a commitment device, even when it's suspended. That's interesting. Lucas: That's the key insight. Fiscal rules are less about rigid enforcement and more about setting a norm. They create a baseline that governments have to explicitly deviate from. That raises the political cost of irresponsible spending. Luna: But critics would say they also prevent necessary spending during downturns, or force austerity that hurts growth. Look at Greece after the euro crisis—they had to run primary surpluses for years under EU rules. Lucas: That's a real tension. The EU's Stability and Growth Pact requires deficits under 3% of GDP and debt under 60%. After the crisis, many countries had to cut spending sharply to meet those targets. That contributed to a double-dip recession in southern Europe. Luna: And those rules have been reformed multiple times. The latest reform in 2024 gave countries more flexibility to negotiate individual fiscal adjustment paths. Lucas: Right. But even with flexibility, the fundamental question remains: do fiscal rules actually constrain behavior, or do governments just find ways around them? There's research showing that countries with fiscal rules tend to have lower deficits and debt, but it's hard to separate cause and effect. Luna: Maybe the countries that adopt rules are the ones that would be fiscally responsible anyway. It's a selection effect. Lucas: Exactly. That's the biggest challenge in evaluating them. But there's some evidence that rules with strong enforcement mechanisms—like Switzerland's requirement to repay deficits—are more effective than weaker ones, like the US's statutory debt ceiling, which gets raised every few years. Luna: The debt ceiling is a perfect example of a rule that doesn't really bind. It's more of a political football. Lucas: Yeah. The US has had a statutory debt limit since 1917, but it's been raised or suspended over a hundred times. It doesn't constrain spending; it just creates periodic crises. Fiscal rules need to be credible to work, and that credibility comes from design and political consensus. Luna: Speaking of political consensus, that's often the hardest part. In a polarised environment, rules get challenged. Lucas: Absolutely. And that's where listener support for shows like this makes a difference—it lets us dig into these topics without trying to sell you anything. A couple of dollars a month is genuinely what keeps these going. If you've gotten something out of our episodes, consider supporting us at buy me a coffee dot com slash fexingo. Luna: Yeah, it really does make a difference. Small contributions add up and keep the podcast ad-free. Lucas: Back to rules: there's also the case of emerging economies. Many have adopted fiscal rules to signal credibility to international investors. For example, Brazil has a spending cap that limits growth of primary expenditure to inflation. It's been controversial, but it helped stabilize debt expectations. Luna: Colombia has a structural balance rule too, based on oil prices. It's similar to Chile's. Lucas: Right. And the IMF has been a big promoter of these rules. By 2023, over a hundred countries had some form of fiscal rule. But the track record is mixed. A 2024 IMF study found that about 40% of rules are either suspended or not complied with within five years of adoption. Luna: So a lot of them are aspirational rather than binding. Lucas: That's a fair characterization. But even aspirational rules can matter if they shape public debate. When a government proposes a budget that would violate a rule, it forces them to justify the deviation. That transparency can be valuable. Luna: I want to ask about the UK. They had the 'fiscal mandate' under George Osborne—a rule to eliminate the structural deficit by a certain date. It was missed, then replaced. Lucas: The UK has had several fiscal rules since 2010. Under the Coalition, the target was to achieve a cyclically adjusted current budget surplus by 2015-16. They missed it. Then they switched to a target for debt to fall as a share of GDP by 2020. That got blown up by COVID. Now they have a rule that debt must fall in five years, which is quite loose. Luna: It seems like the more specific and ambitious the rule, the more likely it is to be broken or changed. Lucas: Yes. There's a trade-off between credibility and flexibility. A rule that's too rigid gets abandoned in a crisis. One that's too flexible doesn't constrain anything. The sweet spot seems to be something like Switzerland's model: strict but with a clear mechanism for temporary deviations and repayment. Luna: What about rules on the spending side, like expenditure ceilings? Lucas: Those are common too. The Netherlands has multi-year spending ceilings for each ministry. They're set in advance and hard to change. That's helped keep spending under control. But again, during COVID, they were suspended. Luna: So in every case, the rule bends but doesn't break in a crisis. That seems like a feature. Lucas: I think that's the right way to see it. Fiscal rules are like guardrails, not prison walls. They keep policy within a normal range, but they have to allow for emergencies. The question is whether the emergency exits are used too easily. Luna: That's the political economy challenge. How do you make a rule that's hard to suspend but not impossible? Lucas: Some countries require supermajorities to suspend, like Germany's two-thirds vote. Others, like Switzerland, require a repayment plan. The EU's reformed rules require countries to submit medium-term plans that show a credible path back to the 3% deficit limit. There's no one-size-fits-all. Luna: So if a listener wanted to check their own country's fiscal rules, where would they look? Lucas: The IMF maintains a Fiscal Rules Dataset. It's publicly available. You can see the type of rule, the coverage, the enforcement mechanism, and whether it's been suspended. It's fascinating to browse. Luna: I'll have to check that out. It's one of those things that sounds boring but actually tells you a lot about a country's priorities. Lucas: Exactly. Fiscal rules are ultimately about commitment. They're a way for governments to tie their own hands and convince markets and citizens that they won't overspend. Whether they work depends on the details—and on whether politicians want them to. Luna: And on whether voters hold them accountable when they break them. Lucas: That's the real bottom line. A rule is only as strong as the political cost of violating it. And that cost is set by us, the citizens.