For countercyclical frameworks and rules to be credible they should operate symmetrically, allowing budget deficits during downturns and accruing surpluses during upturns, otherwise fiscal pro-cyclicality in economic expansions and the deficit bias of fiscal policy would continue, while the credibility of the frameworks and rules would be gradually eroded i.e., it is recommended the adoption of “two-sided” fiscal frameworks and rules that operate symmetrically for downturns and upturns. Countercyclical fiscal policy actions cannot be properly implemented outside a medium-term fiscal framework that takes into account the evolution of the public debt.

There is agreement that procedural and transparency rules should complement the use of numerical rules. Procedural rules should include provisions for making the budget process more “hierarchical,” concentrating power in the hands of those with direct responsibility for ensuring fiscal discipline. They should also include provisions for identifying weaknesses in fiscal institutions and for limiting principal-agent problems by increasing public accountability.

Countercyclical fiscal rules in emerging economies should be based on a structural balance framework. If adjustments for the cyclical component of interest rates are not feasible, the cyclically-adjusted fiscal balances (CABs) and rules should apply at the level of the primary balance (Perry 2005). Moreover, CABs need to be used with some flexibility where structural breaks, output volatility, and national statistical systems complicate the task of estimating potential output and the state of the business cycle. However, the role of CABs should not reduce the importance attached to the monitoring of nominal balances and debt dynamics.

Targeting an overall balance rule is not considered a good practice for countercyclical fiscal policy in the Keynesian view, nor does it allow automatic stabilizers to function freely over the cycle, as the Neoclassical view would recommend. Targeting the primary balance is preferable because it provides a better measure of the stance of fiscal policy. In emerging economies, and in particular in Latin America— given the typical volatility of government revenue and debt service—targeting the overall balance would lead to highly volatile primary spending (Hausmann 2005).

Numerical rules embodied in fiscal frameworks such as the FRLs have several potential advantages: (1) they help contain the deficit bias of fiscal policy and address problems of time inconsistency; (2) they help address the expenditure bias in decentralized countries when top-down rules are imposed; (3) they help reduce the procyclicality of fiscal policy and make countercyclicality possible when cyclically-adjusted indicators are targeted; (4) they serve as a useful market signal in countries vulnerable to contagion effects and sudden shifts in investor confidence; and (5) they help to reduce borrowing costs and macroeconomic volatility, as they contribute to improved investor confidence (Fatás and Mihov 2003; and Kopits 2004b).

Numerical rules need to be consistent with economic conditions and backed by a strong political commitment to adhere to those rules, otherwise they will lack credibility and may encourage officials to subvert them by, for example, reclassifying expenditures 19