Do fiscal rules limit fiscal space?

Abstract

This paper examines the relationship between fiscal rules and fiscal space in Sub-Saharan African (SSA) economies during 1980–2020. Using cross-country empirical methods, we find that fiscal rules reduce fiscal space, contrary to conventional expectations. We argue that this reflects elevated sovereign risk and persistent debt distress in many developing economies. To explain this result, we develop a small open economy New Keynesian model with sovereign default risk. In the model, higher public debt raises perceived default risk and risk premia, increasing borrowing costs and tightening external financing conditions. Consequently, sustainable debt levels decline, reducing fiscal space.