Fiscal Rule and Public Investment in Chile

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. We acknowledge the substantial progress in building a modern institutional framework for fiscal policy made during the past 30 years. Nevertheless, 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. 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 pandemics.