Fiscal adjustment in EU countries:Fiscal adjustment in EU countries:A Balance Sheet ApproachA Balance Sheet Approach
Gian Maria Milesi-FerrettiGian Maria Milesi-FerrettiKenji MoriyamaKenji Moriyama
International Monetary FundInternational Monetary Fund
MotivationMotivation
Debate on the design of fiscal rules and Debate on the design of fiscal rules and reforms of the SGPreforms of the SGP
Frequent adoption of ‘creative accounting’ Frequent adoption of ‘creative accounting’ measuresmeasures
Proposals to move fiscal accounting Proposals to move fiscal accounting towards a ‘balance sheet approach’towards a ‘balance sheet approach’
(e.g., new GFS manual) or to exclude (e.g., new GFS manual) or to exclude investment from deficit calculationsinvestment from deficit calculations
What the paper doesWhat the paper does
Sketches government balance sheetSketches government balance sheet
Defines “cosmetic” (nonstructural) fiscal Defines “cosmetic” (nonstructural) fiscal measuresmeasures
Provides examplesProvides examples
Presents empirical evidence on the Presents empirical evidence on the evolution of net worth in EU countries up evolution of net worth in EU countries up to 1997 and thereafterto 1997 and thereafter
A balance sheet approachA balance sheet approach
Stocks:Stocks: Assets Liabilities
Public capital Gross financial liabilities• Gross government debt• Debt held by publ. inst.• Other
Gross Financial assets
A balance sheet approach (contd)A balance sheet approach (contd)
Flows:Flows:
Change in net worth=Change in net worth=
Flow change in financial assetsFlow change in financial assets- Flow change in financial liabilitiesFlow change in financial liabilities
+ Net public investment+ Net public investment
+ valuation effects+ valuation effects
Key issueKey issue
Valuation of public capitalValuation of public capital– Market value (desirable)Market value (desirable)– Book value (feasible)Book value (feasible)
Financial returns on public capital lower Financial returns on public capital lower than on public debtthan on public debt
Intertemporal budget constraintIntertemporal budget constraint
W(t)=net worthW(t)=net worth
G(t)=government spendingG(t)=government spending
T(t)=government revenuesT(t)=government revenues
1 1(1 ) (1 )t i t ii i tt tT r G r W
1 1(1 ) (1 )t i t ii i tt tT r G r W
‘‘Cosmetic’ measuresCosmetic’ measures
Measures that improve the fiscal balance Measures that improve the fiscal balance and/or reduce gross government debt....and/or reduce gross government debt....
But do NOT reduce the present value of But do NOT reduce the present value of future taxes needed to finance future future taxes needed to finance future spending and repay existing debtspending and repay existing debt
Examples of ‘cosmetic’ measuresExamples of ‘cosmetic’ measures
Sale of public assetsSale of public assets
Securitization operationsSecuritization operations
Capital injections and recapitalizationCapital injections and recapitalization
Off-budget itemsOff-budget items
Quasi-fiscal activitiesQuasi-fiscal activities
Change in government balance sheets:Change in government balance sheets:key questionskey questions
Did fiscal rules lead to “fiscal adjustment”? Did fiscal rules lead to “fiscal adjustment”?
Are changes in government debt Are changes in government debt improving net worth? improving net worth?
Which countries have relied more heavily on Which countries have relied more heavily on sales of public assets?sales of public assets?
Empirical approachEmpirical approach
Collection of data on ‘cosmetic’ measures Collection of data on ‘cosmetic’ measures difficult to undertakedifficult to undertake
Hence indirect approach: compare Hence indirect approach: compare “Maastricht variables” with dynamics of net “Maastricht variables” with dynamics of net worthworth
Limitations of approachLimitations of approach
Misses reforms that alter future taxes and Misses reforms that alter future taxes and spending (e.g.: pension reforms)spending (e.g.: pension reforms)
Large measurement problemsLarge measurement problems
Symmetric reductions of public assets and Symmetric reductions of public assets and liabilities may be desirable (e.g.: liabilities may be desirable (e.g.: privatization)privatization)
Political economy insightsPolitical economy insights
““creative accounting” measures more creative accounting” measures more likely when rules are more stringentlikely when rules are more stringent
Optimistic forecasts more likely when Optimistic forecasts more likely when governments discount the future more governments discount the future more heavilyheavily
Change in public assets and initial debt, 1992-97Change in public assets and initial debt, 1992-97
Austria
Belgium
Denmark
Finland
FranceGermany Greece
Ireland
ItalyLuxembourg
Netherlands
Portugal
Spain
Sweden
United Kingdom
y = -0.17x + 10.9
R2 = 0.23
-30
-20
-10
0
10
20
30
40
0 30 60 90 120 150
Government debt in percent of GDP (avg 1990-92)
Cha
nge
in a
sset
s, 1
992-
97 (p
erc.
of G
DP)
Change in public assets and liabilities, 1992-97Change in public assets and liabilities, 1992-97
Austria
Belgium
Finland
France
Germany
Italy
Netherlands
Spain
Denmark Sweden
United Kingdom
y = 0.73x - 11.8
R2 = 0.73
-30
-25
-20
-15
-10
-5
0
5
10
15
20
-10 -5 0 5 10 15 20 25 30 35
Change in liabilities
Cha
nge
in a
sset
s
Changes in net worth and changes in liabilities, 1992-97Changes in net worth and changes in liabilities, 1992-97
0
10
20
30
40
50
60
70
80
90
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
East
West
North
Austria
Belgium
Finland
France
Germany
Italy
Netherlands
Spain
Denmark
Sweden
United Kingdom
y = -0.27x - 11.8
R2 = 0.28
-25
-20
-15
-10
-5
0
-10 -5 0 5 10 15 20 25 30 35
Change in liabilities
Cha
nge
in n
et w
orth
Figure 2. Changes in government liabilities and in net worth: 1992-1997
Change in public assets and liabilities, 1997-2002Change in public assets and liabilities, 1997-2002
Portugal*
United KingdomSweden
Denmark
SpainNetherlands
Italy Germany
France
Finland
Belgium
Austria
y = -0.09x - 2.7
R2 = 0.01
-15
-10
-5
0
5
10
15
20
-25 -20 -15 -10 -5 0 5
Change in liabilities
Cha
nge
in a
sset
s
Changes in govt liabilities and net worth, 1997-2002Changes in govt liabilities and net worth, 1997-2002
Portugal*
United Kingdom
Sweden
Denmark
SpainNetherlands
Italy
Germany
France
Finland
Belgium
Austria
y = -1.06x - 2.3
R2 = 0.66
-15
-10
-5
0
5
10
15
20
25
30
35
-25 -20 -15 -10 -5 0 5
Change in liabilities (percent of GDP)
Cha
nge
in n
et w
orth
(per
cent
of G
DP)
Growth forecast and budget balanceGrowth forecast and budget balance
Austria
BelgiumFinland
France
GermanyIreland
Italy
Netherlands
Portugal
Spain
Greece
y = -0.26x - 0.58
R2 = 0.59
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
-8 -7 -6 -5 -4 -3 -2 -1 0
Average budget deficit, 1995-1997 (percent of GDP)
Gro
wth
fore
cast
(dev
iati
on fr
om C
onse
nsus
)
Summary of findingsSummary of findings
1992-1997 Changes in financial liabilities 1992-1997 Changes in financial liabilities reflect primarily changes in public assets;reflect primarily changes in public assets;
1998-2002 Change in financial liabilities 1998-2002 Change in financial liabilities reflect primarily changes in net worthreflect primarily changes in net worth
Governments with more serious fiscal Governments with more serious fiscal problems tend to be more optimistic than problems tend to be more optimistic than markets about growth prospectsmarkets about growth prospects
ConclusionsConclusions
Fiscal rules can be helpful...Fiscal rules can be helpful...
But it is important to understand the But it is important to understand the incentives they set in place....incentives they set in place....
...and monitor fiscal developments more ...and monitor fiscal developments more broadlybroadly