Functionality of Fiscal Rules in a Low Interest Rate Environment – New Empirical Results for Swiss Cantons

Philipp Weber, Laura A. Zell, Lars Feld and Christoph Schaltegger

No 11351, CESifo Working Paper Series from CESifo

Abstract: The zero lower bound era introduced a new perspective on the functionality of fiscal rules. With such low interest rates, the argument goes, extending debt financed public investment spending would be reasonable and thus existing fiscal rules too restrictive. Using data of Swiss cantonal public finances between 1990 and 2020, we investigate as to how fiscal rules affect fiscal variables in an environment with low interest rates. In addition to a dynamic model with a bias-corrected least square dummy variable (LSDVC) estimator, the Forecasted Average Treatment (FAT) approach allows us to exploit Switzerland’s unexpected and substantial interest rate drop in 2015 following the termination of the Swiss Franc-Euro peg. The methodological novelty of this approach lies in the investigation of an exogenous shock in absence of a control group. Our results show, first, that fiscal rules constrain public debt and total spending, but not investment spending. Second, variation in the interest rate level has opposing effects on different types of public deficits, but fiscal rules retain their overall constraining effect in a low interest rate environment. Third, we find varying reactions to the interest rate shock depending on rule stringency, but public investment is not systematically more constrained by strict rules.

Keywords: fiscal rules; zero-lower-bound; interest rate shock; public investment (search for similar items in EconPapers)
JEL-codes: E43 E62 H54 H63 H74 (search for similar items in EconPapers)
Date: 2024
New Economics Papers: this item is included in nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_11351

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