Codified or Compromised: Correction Mechanism Design and Post- COVID Fiscal Recovery in Emerging Markets

INTRODUCTION

The COVID-19 pandemic caused a major expansion in government spending worldwide, forcing many countries to either exceed or abandon their existing fiscal rules. Fiscal rules are limits on budget deficits, public debt, or government expenditure made to control long-term fiscal discipline and reassure investors about the stability of public finances. However, the scale of the pandemic shock meant that following these rules was not feasible. The governments of Emerging Markets and Developing Economies (EMDEs) chose to prioritize economic stabilization over meeting fiscal targets as emergency expenditure surged exponentially. Most fiscal frameworks include escape clauses that allow governments to deviate from fiscal rules temporarily. These are exercised during extraordinary events such as recessions, financial crises, or natural disasters. Escape clauses serve to provide fiscal flexibility, specifying that deviations should be temporary and followed by a return to pre-crisis rules as conditions ease. During the COVID-19 crisis, most countries formally invoked these clauses, effectively suspending fiscal constraints to accommodate emergency spending. The activation of escape clauses raises an important question about fiscal credibility, that is, how quickly and credibly governments return to fiscal discipline after the crisis. Correction mechanisms strengthen escape clauses by dictating how and when countries return to pre-crisis fiscal rules. In this policy proposal, we use the reference of the escape clause and the subsequent reliance on correction mechanisms to measure fiscal discipline.