Do Fiscal Rules Cause Better Fiscal Balances? A New Instrumental Variable Strategy

This paper estimates the causal effect of fiscal rules on fiscal balances in a panel of 142 countries over the period 1985-2015. Our instrumental variable strategy exploits the geographical diffusion of fiscal rules across countries. The intuition is that reforms in neighboring countries may affect the adoption of domestic reforms through peer pressure and imitational effects. We find that fiscal rules correlate with lower deficits, but the positive link disappears when endogeneity is correctly addressed. However, when considering an index of fiscal rules’ design, we show that well-designed rules have a statistically significant impact on fiscal balances. We conduct several robustness tests and show that our results are not affected by weak instrument problems.