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Fiscal rules, escape clauses, and credit markets: Evidence from financial crises

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  • Aguilera-Torres, Boris
  • Talbot-Wright, Hipólito
  • Villena, Mauricio G.

Abstract

This paper investigates whether escape clauses in fiscal rules mitigate the negative effects of financial crises on domestic credit markets. Using a dynamic panel of 56 countries from 1985 to 2015, we estimate the impact of escape clauses on both domestic bank credit and sovereign bond spreads during crises. Our results show that escape clauses significantly soften the contraction in credit and reduce sovereign borrowing costs when crises occur. In contrast, discretionary fiscal deviations—those not supported by legal clauses—fail to produce similar benefits. These findings suggest that institutionalized fiscal flexibility plays a stabilizing role in periods of financial distress by supporting market confidence and access to finance. To our knowledge, this is among the first empirical studies to assess the role of escape clauses during idiosyncratic banking crises.

Suggested Citation

  • Aguilera-Torres, Boris & Talbot-Wright, Hipólito & Villena, Mauricio G., 2025. "Fiscal rules, escape clauses, and credit markets: Evidence from financial crises," Economics Letters, Elsevier, vol. 256(C).
    • Handle: RePEc:eee:ecolet:v:256:y:2025:i:c:s0165176525004859
    DOI: 10.1016/j.econlet.2025.112648
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • O23 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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