The effects of fiscal rules on budget deficit: Does democracy matter?

Abstract

This paper aims to analyse the extent to which democracy shapes the relationship between fiscal rules and budget deficits. To attain this objective, we estimated different fiscal reaction functions for a sample of 97 countries over the period 1985–2021. Our results show that fiscal rules reduce primary budget deficits. Furthermore, the paper establishes that this effect diminishes with democracy as a marginal increase in fiscal rules strength reduces the primary budget only in weak democracies while in strong democracies they do not, indicating that fiscal rules and democracy are substitutes to attain fiscal discipline. Our results are robust to the exclusion of EU countries members, alternative methods dealing with endogeneity or time-invariant variables and the inclusion of other determinants of primary budget deficit as explanatory variables. This suggests that fiscal rules and democracy are substitutes. However, when dealing with the fiscal framework, we find that fiscal rules and democracy are substitutes only in new democracies and under high indebtedness.