On Fixed and Variable Fiscal Surplus Rules

Both emerging and developed economies increasingly use fiscal rules. This paper analyzes the effects of two alternative fiscal rules on debt sustainability. The fixed surplus rule fixes the ratio of primary surplus to gross domestic product (GDP), and the variable surplus rule sets the primary surplus as a linear function of the debt-to-GDP ratio. A simple debt dynamics equation is constructed that incorporates real shocks, and the probability of exceeding the critical debt level is simulated using Monte Carlo techniques. The results show that the variable surplus rule performs better than does the simple fixed surplus rule by reducing debt sustainability concerns and the necessary medium-term primary surplus. This result hinges on government ability to commit credibly to the variable surplus rule in the medium run.