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Journal Article
Can fiscal rules decrease the probability of a sudden stop crisis?
2024
Overview
This work studies the effects that fiscal rules have on the probability of a sudden stop of net financial flows using data from 96 countries for the period 1985–2016. The estimates of several probit models show that fiscal rules could lower the probability of a sudden stop if they are formally enforced. Enforcement of supranational debt rules is important in lowering the likelihood of a country going through a sudden stop. I find that enforcement of supranational debt rules makes the countries that adhere to supranational debt rules less vulnerable to sudden stops by roughly 3.33 to 4.07 percentage points depending on the specifications. This could be due to an increase in the credibility of the country in the eyes of investors following the stronger commitment of the governments to adhere to these rules. These effects have been estimated using different specifications and models. The results are robust. On the other hand, I do not find enough statistically significant evidence regarding the effects of monitoring and well-defined escape clauses. The results about fiscal rules without taking these mechanisms into account indicate that fiscal rules on their own do not decrease the probability of a sudden stop. I find evidence that improvements in the current account balance, economic growth and institutional quality make a country less vulnerable to sudden stops, while a greater credit level, trade openness, and short term external debt increase the likelihood of a crisis. These estimates are in line with the sudden stop literature.
