Fiscal Rule and Public Investment in Chile

Produced by: 
Pontificia Universidad Católica de Chile
Available from: 
February 2020
Paper author(s): 
J. Rodrigo Fuentes
Klaus Schmidt-Hebbel
Raimundo Soto
Topic: 
Fiscal Policy - Public and Welfare Economics
Year: 
2021

We use three different approaches –narrative approach, counterfactual synthetic control method, and DSGE model—to assess the design and operation of the Chilean fiscal rule and its impact on public investment. While there has been substantial progress in building a modern institutional framework for fiscal policy in the past 30 years, we find that the rule is incomplete in at least two dimensions: it lacks an escape clause and it needs supplementing the budget balance rule with a debt rule. The former was made patent with the breaching of the rule in 2009 and the subsequent inability of the authorities to steer fiscal accounts back to its long-term sustainable path. The latter showed in the speedy built up of the public debt in the last decade as a result of the need to finance fiscal deficits. Empirical evidences does not allow to conclude that there has been a negative impact of the rule on public investment.. We propose a number of reforms to existing fiscal institutions, including improving on the transparency and accountability of the institutional framework, a reformulation of the rule to consider a multi-year horizon planning of public finance (including investment plans, balance sheet management), escape clauses, and a debt anchor among others. This will complement the actual fiscal framework, especially nowadays when the fiscal stance has deteriorated significantly and is expected to worsen as a result of the Coronavirus pandemic.

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