Fiscal institutions are crucial for every country, but especially for those that are resource-intensive and they become particularly important in pandemic times. In individual countries’ responses to the COVID-19 pandemic, diversity in fiscal policy frameworks was a differentiating element. Richer countries or those that pursued responsible fiscal conduct in the years before the arrival of the virus were better able to strengthen health systems and deliver fiscal transfers, subsidies, and guarantees. This allowed faster recovery from the shock. Aggressive fiscal responses to the pandemic had positive effects on stock markets, currencies, industrial production, employment, confidence, and sovereign risk premiums in the countries that implemented them. There is also evidence that the effects were greater in advanced economies and in those with lower public debt. Most countries that had fiscal space or sovereign wealth funds were able to use these to deal with the economic and social effects of the pandemic.
In contrast, the poorest countries in Africa, the Americas, and Asia had limited leeway to respond, bolstering spending or forgoing revenue by less than 2.5 percent of GDP. Thus it will take years for them to recover from the economic and social effects of the pandemic, with significant negative impacts on output and income distribution. The difference in many cases reflects the presence or absence of an institutional framework for fiscal policy. Without an institutional framework for fiscal policy, government spending is bound by the amount of public resources available in a given year reflecting mainly tax revenue and a limited capacity to borrow. The problem with this mechanism is that fiscal revenues tend to be procyclical, and a spending policy financed with current revenues and constrained credit only exacerbates rather than mitigating the economic cycle. This generates pernicious macroeconomic effects on the volatility of key variables such as the exchange rate, inflation, and interest rates, with repercussions on investment, economic growth, and employment. It also puts at risk the long-term sustainability of financing required for more permanent policies such as public health, education, housing, and pensions.
This problem is even more pronounced for countries like Chile that are natural-resource-intensive, where commodity exports typically account for over 60 percent—and in some cases more than 90 percent of total exports. In these cases, fiscal revenues depend not only on GDP but also on the prices of the goods the country produces and exports. In such economies it is even more important to establish an institutional framework to guide fiscal policy decisions.
Such a framework should be composed of at least three elements: a fiscal rule with a medium- to long-term perspective, sovereign wealth funds, and an independent fiscal institution such as an advisory fiscal council.
Beyond the sustainable financing of social policies, an institutional framework allows for a longer-term orientation for fiscal policy, which otherwise would be implemented with a time horizon in line with government terms. Thus, an appropriate fiscal framework highlights the existence of inter temporal budget constraint that contemplates very long time horizons. This is crucial for responding to a shock such as the COVID-19 pandemic, both when resources need to be used and when it is necessary to carry out a fiscal consolidation to ensure the long-term sustainability of public finances.
It is essential that countries especially emerging market and resource-intensive nations have a fiscal framework with the three pillars.
