Fiscal Discipline

Charles WyploszThe Graduate Institute, Geneva

Conference on Fiscal PolicyIMF, June 2, 2009

Outline

Fiscal discipline is hard to come by

Institutions matter

Rules are arbitrary

Bureaucrats are great but unwelcome

How to affect politicians’ incentives?

Fiscal discipline is hard to come by

OECD Countries

20

30

40

50

60

1970 1975 1980 1985 1990 1995 2000 2005

Fiscal discipline is hard to come by

Latin America

10

15

20

25

30

35

40

45

50

55

60

1970 1975 1980 1985 1990 1995 2000 2005

Fiscal discipline is hard to come by

Asia

20

25

30

35

40

45

50

55

60

65

70

1970 1975 1980 1985 1990 1995 2000 2005

Reasons for indiscipline

• Public debt is an externality Private beneficiaries of spending and tax

payments Social cohesion Mechanism for internalizing

• Intertemporal inconsistency Political parties (coalitions vs. single party

majority) Political regimes

Institutions matter

• Large literature Political regime

• Democracies or not• Presidential vs. parliamentary• Majority vs. coalitions

Budget-setting process• Role and rights of parliament• Role of Finance Minister• Nesting of decisions• Rules

Institutions matter

• Large literature• Difficult to apply

Reforms are rare and in response to unusual circumstances

No simple lesson from literature• Except perhaps role of Finance Minister

Many other considerations, anyway

Fiscal rules

• Formal budget rules Stability Pact

• Numerical deficit ceiling (3% rule)• External monitoring and sanctions• Some effect, maybe

Stability pact effect

40

50

60

70

80

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

EMU Non-EMU OECD

Convergence

EMU starts

Fiscal rules

• Formal budget rules Stability Pact Swiss “brake” (2003)

• Aims at budget balance over the cycle• Ties expenditures to expected revenues (G=kT)• Explicitly allows for countercyclical spending (k a

function of the output gap)• Bygones are not bygones

Fiscal rules

• Formal budget rules Stability Pact Swiss “brake” Chile and structural budget rule

• Similar to Switzerland

Swiss brake

Switzerland

30

40

50

60

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Chile

0

10

20

30

40

50

1990 1992 1994 1996 1998 2000 2002 2004 2006

Fiscal rules

• Formal budget rules Stability Pact Swiss “brake” Chile structural budget rule Sweden and many more: multiyear horizon

Sweden

Sweden

40

50

60

70

80

90

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Note:Rules often

established afterdebt reduction

Fiscal rules

• Formal budget rules Stability Pact Swiss “brake” Chile structural budget rule Sweden and many more Golden rules

• Germany• UK

All inclusive

Exclude “productive”investment

Fiscal rules

• Formal budget rules• Informal budget rules

The British code for fiscal stability The Dutch medium-term framework

• Debt sustainability• Medium term = planned duration of Parliament• Embedded in election platform • Relies on expert estimation (CPB)

The Dutch medium-term framework

The Dutch medium-term framework

Netherlands

40

50

60

70

80

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Fiscal rules

• Formal budget rules• Informal budget rules• Inherent arbitrariness

Deficit vs. debt Gross, net, contingent liabilities Deficit/debt vs. spending

Fiscal institutions

• Dealing with a large number of contingencies Cannot rely on rules

• Dealing with the deficit bias Cannot rely on the political infrastructure

• A solution must involve: Judgment Ability to counteract or resist pressure

Fiscal institutions

• Solution 1 Delegate budget to Finance Minister

• Solution 2 Delegate budget balance to independent

council

• Solution 3 Advisory council to act as counter-pressure

body Can be embedded into budget process

Politicians reject empowering bureaucrats

• The misleading similarity with central banks Weight of history Income redistribution

• The difficulty of separating out budget balance from spending and revenue decisions

• Why are rules preferred to bureaucrats?

Conclusions

• Affect incentives Can be evolutionary

• The Dutch approach Technical skills

• The Wisemen approach Independence

• Europe’s special case Replacing the Stability Pact