This paper characterises fiscal policy rules for Sri Lanka using alternative policy reaction functions for the sample period 2003:Q1 to 2014:Q2. It estimates fiscal policy rules widely used in literature including simple tax difference rules, primary balance rules and Taylor-type fiscal rules.
The findings suggest that, first, the fiscal authority responds to changes in output gap and government expenditure moderately. Second, tax smoothing is moderately high and statistically significant. Third, contemporaneous fiscal rules are better than backward-looking rules in characterising the fiscal reaction behaviour in Sri Lanka. Fourth, deficit rules are marginally better than debt rules in matching with Sri Lankan data. Fifth, the fiscal policy in the country is procyclical rather than countercyclical, similar to many other countries. Finally, the contemporaneous Taylor-type fiscal rule that responds to output, government expenditure and deficit while smoothing out tax rate describes the fiscal policy behaviour of Sri Lanka more appropriately than other alternative fiscal rules estimated.