Fiscal Rules, Robust Correction Mechanisms, and Sovereign Spreads

Both policy advice and economic theory advocate for fiscal rules with a clear anchor that reflects fiscal risk and a robust correction mechanism that implements a more ambitious fiscal consolidation when fiscal risk is higher. However, among more than 120 countries with fiscal rules, only six are identified as implementing such robust correction mechanisms: Armenia, Costa Rica, Cyprus, Czech Republic, Poland, and Slovakia. Using synthetic control methods and dynamic panel regressions, this paper finds that the introduction of fiscal rules with robust correction mechanisms has been particularly effective in these countries, triggering a persistent median spread reduction of about 25 percent, or 75 basis points, over one year.