Can fiscal rules decrease the probability of a sudden stop?: empirical evidence from developed and developing economies
Date
2020
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Publisher
University of Delaware
Abstract
This work studies the effects that fiscal rules have on the probability of a sudden stop of net financial flows using cross-country panel data from 96 developed and developing countries for the period 1985-2016. The estimates of several probit models show that fiscal rules could lower the probability of a sudden stop if they are formally enforced. Enforcement of supranational debt rules is important in lowering the likelihood of a country going through a crisis. I find that enforcement of supranational debt rules makes the countries that adhere to supranational debt rules less vulnerable to sudden stops by roughly 3.33 to 4.07 percentage points depending on the specifications. This could be due to an increase in the credibility of the country in the eyes of investors following the stronger commitment of the governments to adhere to these rules. These effects have been estimated using different specifications and models. The results are robust. On the other hand, monitoring and well-defined escape clauses could also be mechanisms that could make the economy less vulnerable, but I do not find enough statistically significant evidence when I include them in the specifications. The results about fiscal rules without taking these mechanisms into account indicate that fiscal rules on their own might not have an impact on or they might increase the vulnerability of a country to sudden stops. I find evidence that improvements in the current account balance, economic growth and institutional quality make a country less vulnerable to sudden stops, while a greater credit level, trade openness, and short term external debt increase the likelihood of a crisis. These estimates are in line with the sudden stop literature.
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Keywords
Financial flows, Fiscal rules, International economics, Sudden stops