A fractured world puts public finances to the test
After decades of integration, the global economy is splitting apart. Brexit, the pandemic, US–China trade tensions, the war in Ukraine and conflict in the Middle East have all restricted the flow of goods, capital and people. A widely used index of geopolitical fragmentation has risen steadily since the global financial crisis.
For governments, fragmentation is not only a trade problem; it is a fiscal one. Supply-chain disruption slows growth, while defence spending and targeted support for households push up expenditure. The median debt-to-GDP ratio across a broad sample of countries has climbed sharply since the late 2000s. So which policy frameworks help economies withstand these shocks?
A SEACEN working paper by Gazi Salah Uddin, Anh H. Le, Naoki Yago, John Beirne and Donghyun Park, Global fragmentation, fiscal policy, and economic growth: a cross-country analysis (February 2026), offers a clear answer: credible fiscal rules, especially when paired with an independent central bank.
The authors build a panel of 121 economies, 34 advanced and 87 emerging and developing, covering 1985 to 2023. They treat the global fragmentation index of Fernández-Villaverde et al. (2024), which combines 16 indicators of trade, financial, mobility and political fragmentation, as an external shock that no single country controls.
They then trace how output, consumption, investment, productivity and public debt respond over the following six years, using local projections. Crucially, they compare countries with and without a fiscal rule in place, drawing on IMF data on debt, budget balance, expenditure and revenue rules. Adoption has been striking: only 5% of sample countries had a fiscal rule in 1985, against 97% by 2023.
Key findings
Fragmentation is costly and long-lasting. A rise in global fragmentation risk lowers real GDP, consumption and investment, with investment hit hardest. It also depresses total factor productivity, a worrying signal for long-term growth. Strikingly, the debt-to-GDP ratio rises even as GDP falls, meaning the stock of debt itself grows. In countries without fiscal rules, these effects persist for around five to six years.
Fiscal rules soften the blow. In countries with a fiscal rule, the damage is smaller and fades within two to three years. The mitigating effect is modest on impact but builds over the medium to long run. Fiscal rules also contain the rise in debt and limit the fall in productivity, consistent with their role in protecting investment. All four rule types help, with revenue rules showing the strongest effect.
Spending on the essentials is protected. Without fiscal rules, fragmentation shocks lead governments to cut total spending, including on education, health and the environment. With rules in place, these cuts largely disappear, even though debt rises less. By preserving fiscal space in good times, rules let governments protect the spending that builds human capital.
Emerging economies gain most. Fiscal rules are more effective in emerging and developing economies than in advanced ones, with results driven mainly by Asia and Africa. They are especially powerful where institutions are weak: low democracy, low political stability and high corruption. In such settings, a rule acts as a credible commitment that reduces policy uncertainty.
Climate exposure and inequality. Countries facing high climate risk suffer larger output losses and debt build-ups from fragmentation shocks, and fiscal rules mitigate both. Fiscal rules also make growth more inclusive: without them, low-income households lose a larger share of income than high-income households when geopolitical risk rises; with them, the poor are harmed less.
Fiscal rules and central bank independence: a powerful partnership
Perhaps the most novel finding concerns the interaction between fiscal and monetary frameworks. Standard theory holds that fiscal sustainability is more likely under monetary dominance. When an independent central bank is firmly committed to price stability, governments cannot rely on money creation or inflation to erode their debts. They must adjust the primary balance instead.
The authors test this using a de jure central bank independence (CBI) index built from central bank legislation, splitting countries into high and low CBI relative to the sample median. Countries that combine a fiscal rule with high CBI weather fragmentation shocks markedly better. Although the initial output response is slightly sharper, the medium- and long-term gains far outweigh this cost. The debt-to-GDP ratio stabilises on impact, and productivity recovers quickly, even rising above its pre-shock path in the long run.
A similar pattern emerges using exchange rate regimes: a fiscal rule combined with a floating exchange rate, a proxy for independent monetary policy, also substantially reduces the damage.
The logic is one of mutual reinforcement. Fiscal rules serve as a commitment device for long-term sustainability, while central bank independence removes the government’s temptation to break that commitment by leaning on the printing press.
Implications for central banks
For central banks, the message is that their independence is not only a safeguard for price stability but also a pillar of fiscal resilience. As debt reaches record highs and fragmentation raises spending pressures, guarding against fiscal dominance becomes more important, not less. Central banks should defend their legal and operational independence and communicate clearly that they will not accommodate monetary financing. They can also support robust, well-designed fiscal rules with escape clauses through policy dialogue, especially in emerging economies. Closer analysis of geopolitical risk in macro-financial surveillance would further help policymakers anticipate fiscal strains before they spill over into inflation.
Note: This blog is based on SEACEN working paper
https://www.seacen.org/publication-doc/WP03_2026_Final.pdf