The document discusses Chile's use of a budget surplus rule (BSR) which requires the central government budget to maintain a structural surplus of 1% (later reduced to 0.5%) of GDP. The BSR aims to make fiscal policy less procyclical and provide more flexibility/autonomy for monetary policy. It resulted in lower output/interest rate volatility. However, the rule lacks flexibility and welfare gains would increase by allowing exceptions. The BSR works best when complementing an independent central bank targeting inflation and in economically integrated countries requiring policy tools to address shocks.

1. Erico Wulf

2.  To reinforce the relevance of rules for fiscal
policies , specially when structural incomes
increases, or more autonomus monetary policy
is needed.-
 To analize the implications of fiscal rules, for
monetary policy effectiveness ,and stabilizing
business cycle.
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3.  To Review the literature about the issue of budget
surplus and policies .-
 To Set the framework for analisis: Three questions ,
theoretical considerations. and necessary conditions
for BSR
 To Analyze the main characteristics and implications
of BSR (Budget surplus rule) applied in Chile.
 Concluding remarks for economic policy
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4.  The principle of Effective market classification (complement to the Tinbergen ´s
principle) ,set fiscal policy role for internal stability , while monetary policy for
external stability .(Mundell 1968)
 Fiscal Policy might support an economic recovery , or to smooth business cycle
fluctuations. (Gordon 1983). Unfortunately, public revenues and expenditures do not
react similarly. It takes more time to adjust expenditure downward after
the recession is over. Besides, public incomes have low elasticity to
economic activity.-
 Thus, while fiscal policy might help to obtain economic recovery , it might also
become a constraint for keeping a sustainable economic growth pattern (Pasten and
Cover 2010), because of deficits. This was the case of most LA countries in the XX
century.
 Chile’s commitment to fiscal responsibility since the mid-1980s has been improved
by introducing since the year 2001, a more explicit medium-term orientation fiscal
rule (Vial, 2001; Arellano, 2005,Marcel 2001): 1%+Budget surplus . Later that
decade (2008), this rule was revisited downward (0,5%+).
 The structural budget surplus, can not becomes a fixed target. ( Vergara, 2002;
Rodriguez, 2007; Frankel, 2011; Larraín, 2011; Schmidt-Hebbel, 2012).

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5.  1) What are the main advantages of such a
policy rule ?
 2) Does the policy of budget surplus, make any
sense in a country with huge social needs?
 3) Which countries can have budget surplus
rules ?
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6.  Lower output volatility and better policy efficiency . As it has been
demonstrated with other policy rules, a fiscal policy rule also brings about lower
output volatility. Between 1999-2005 and following the BSR ,output volatility in Chile
decreased by 32-33%. Besides, coupled with other policy decisions ,it decreased
volatility further by 25-27% (Larrain and Parro, 2006; Kumhof and Laxton, 2010).
 Lower interest rate costs ,and More investment opportunities. Before
the fiscal policy rule Chile was a net debtor by 9% of GDP. But it became a net
creditor by 4% of GDP. As a consequence borrowing costs went down from 7% in
1999 to 3.35% in 2011 (Larraín, 2011).
 Monetary policy has a back up for more flexibility and autonomy. The
Chilean experience, indicates that fiscal policy became less correlated with the
economic cycle after the structural budget surplus was applied, decreasing from
0.77 (1990-2000) to 0.57 (2001-2011). Therefore, a fiscal policy with a counter
cyclical instead of a pro-cyclical approach, complements better monetary policy,
such that output volatility decreases (Larraín, 2011).
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7.  If fiscal policy deals with internal balance, it has a
relative autonomy for attending social needs, such
that economic growth ,might be also a stronger tool
for social needs.
 In the chilean experience, more than 45 % of poverty
reduction between 1900-2010, was because of
economic growth.
 Therefore, social needs might be or might not ,be a
restriction for BSR, as long as such a policy rule, fit
properly the balance between growth and social
needs .
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8. (1) Surplus = T- G ………. but T = tQ
Multiplying and dividing tQ by Qⁿ/ Qⁿ
(2) Surplus = tQⁿ (Q/Qⁿ) – G
From equation (2) , there are three sources of surplus
variations:
 Self stabilization mechanism :(Q/Qⁿ) (economic impact on
the budget)
 Discretional fiscal policy : changes in t (taxes), and G
(Government
expeditures) (budget impact on the economy)
 Economic growth which impact positively in Qⁿ
The slope of the BS equation (2) , is the (marginal rate of
taxes):The higher the marginal tax rate ,the steeper the slope of
BS line.
 t=(T/Q)ⁿ((∆T/Tⁿ)/ (∆Q/Qⁿ))
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9. 01/06/17
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BL1.1
BL1
Surplus
Deficit
Q/Qⁿ =1Q/Qⁿ=0,9
∆G
GDP drop -1,8%

10.  a.-An independent Central Bank, which set an inflation target
for monetary policy ,and it is autonomous for its policy
decisions .-
 b.-Given Trade and financial integration to global economy, it
requires for policy makers, to have economic policy tools, fully
at their disposal to deal with the impact of unexpected shocks.
 c.-Long run commitment for stable (low volatility)economic
growth.
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11.  The rule was initially not regulated by law. However, in the year 2006, a Fiscal
Responsibility Law was enacted ,which also introduced new rules on the investment of
accumulating assets. In 2011 an expert panel ,suggested to implement a fiscal council
advisory board.
 The structural surplus rule, only covers the central government and deals only with
income, keeping expenditure on its mid-term trend.
 It states that the central government’s overall structural balance ,should in every year
equal a surplus of 1% (0.5% effective since 2008) of actual GDP.
 The structural balance equals structural revenues plus interest on net government assets
(which are positive in Chile), minus actual expenditures on goods and services.(net of
business cycle fluctuations).
 Structural revenue is determined by two independent panels of experts and reflects what
tax revenue would have been ,if the economy had operated at potential rather than actual
output, and what copper revenue and other derivatives would have been, considering a
long-term reference of world copper price.
 The resulting counter-cyclical of government deficits ,isolates government expenditures on
goods and services from the cycle and keeps them growing along with trend output.
 No distinction is made between government consumption and investment expenditures,
because this is difficult to do in practice.
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12.  A positive surplus target, implied a significant asset accumulation by the Chilean
government(positive externality), even though when it was implemented, it only
pretended to provide savings for future social commitments, and to address
contingent liabilities.
 The 2006 Fiscal Responsibility Law set rules for the investment of surpluses.
These rules envision investment in a government pension fund, gradual central
bank recapitalization, and a Fund for Economic and Social Stabilization (FESS).
 In May 2007, following an expert panel recommendation, a reduction in the
surplus target from 1% to 0.5% of GDP was announced, to be effective in 2008.
 The initial target of 1% implied that government asset accumulation over time
(2007-2016) was 10% of GDP on average, which is hard to keep when it comes
to solve social demand arising from growth (Engel, Marcel, and Meller , 2007).
Besides, the welfare gains from following this rule without some flexible clause,
are lower (18%), than those obtainable by implementing fiscal policy rules with a
flexible clause to break the transitory rule down (Engel, Neilson and Valdes,
2011).
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13.  Better coordinated and consistent macroeconomic policies
mean less output volatility (Larrain and Parro, 2006), less
efficiency and welfare losses (Kumhof and Laxton, 2009),
less interest rate volatility (Rodriguez, 2006), and less
exchange rate volatility (Velasco, 2010), and therefore
increasing the effectiveness of the institutional framework
for economic policy design.
 However, the welfare gains from following a fiscal rule
without flexibility, are lower (18%), than those obtainable by
implementing fiscal policy rules with a flexible clause(Engel,
Neilson and Valdes, 2011).
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14.  Budget surplus rule has positive externalities, such as
lower economic growth volatility, better policy
coordination, and a more effective Central Banks role
,to solve the unexpected shocks.-
 BSR , is the back up for a more autonomous action by
Central Banks to face Exchange rate fluctuations.-
 BSR , requires some flexibility to increase welfare
gains.-
 Therefore, a fiscal policy with a counter-cyclical profile,
complements better monetary policy, such that
output volatility decreases .
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