Abstract and Keywords
This article discusses first, in some detail, Chile's fiscal policies and how they were applied. Much thinking and design went into this approach—some of it local, some of it adapted from successful experiences such as that of Norway. It also examines the economic results of the shift in fiscal policy. The effects on fiscal variables were large: a sharp drop in public debt and record fiscal surpluses in years of high copper prices. This fiscal prudence also mattered for some key macro variables, among them the real exchange rate and the volatility of output growth. The basic message is simple: shifting from a procyclical to a mildly countercyclical fiscal stance helped stabilize both relative prices and economic activity. The article then considers the political economy of the problem. What political failures existed and how did the rule help alleviate them? It addresses these questions with the help of a simple model, which is used to organize and motivate the discussion of Chile's budget politics.
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