Download plans

Chipping Away at Public Debt
Sources of Failure and Keys to Success
in Fiscal Adjustment
Paolo Mauro
Fiscal Affairs Department
International Monetary Fund
The views expressed herein are those of the authors and should not be attributed to the
IMF, its Executive Board, or its management.
Motivation/Background

The state of the public finances in advanced
economies: taking stock of where we are now
and where we need to go.
Fiscal Outlook in Advanced Economies
(in percent of GDP)
2.0
0.0
-2.0
-4.0
-6.0
-8.0
Overall Balance
-10.0
2000
2002
2004
2006
2008
2010
2012
2014
2016
2014
2016
120
110
Gross Government Debt
100
90
80
70
60
2000
2002
2004
2006
2008
2010
2012
3
Fiscal Challenge: Stylized Facts
The scale of the debt problem is unprecedented
140
G-7 PPP-Weighted Public Debt, 1950-2016, percent of GDP
120
100
80
60
40
20
Source: IMF Fiscal Monitor April 2011
2015
2010
2005
2000
1995
1990
1985
1980
1975
1970
1965
1960
1955
1950
0
Germany
Italy
Netherlands
CAPB 2010 (percent of GDP)
France
Req. CAPB by
2020 to reach
60% debt in 2030
Spain
Req. CAPB to
stabilize 2010
debt levels
United Kingdom
Portugal
United States
IMF Staff Calculations.
Calculations for Japan based on net debt.
Ireland
Greece
Japan
-8 -6 -4 -2
0
2
4
6
8
10
What we do in the book
Analytical Framework

Previous empirical studies identified fiscal
adjustment episodes on the basis of ex post
outcomes.

Instead, we approach fiscal adjustment plans on
the basis of large envisaged reductions in debts
and deficits.



One learns from successes but also failures.
Compare ex post outcomes with ex ante plans
Avoids sample selection / survivorship bias
What we do: two methods
1.
Individual Country Case Studies for each of the
G7 countries
2.
Cross-Country Statistical Analysis for the
three-year plans of all EU Countries, 19912007.
G-7 Fiscal Adjustment Plans
Country
Canada
Adjustment Plans
Germany
Comments/Outcome
1985-91 B. Mulroney
• Reduce overall deficit by 3½ percent of
GDP over six years.
Overall deficit objectives met, though not
sufficiently ambitious in the first place.
1994-97 J. Chretien
• Reduce overall deficit by 3 percent of GDP
over three years.
Successfully met objectives and attained
long-lasting reversal of debt dynamics
Plan Barre, 1976–77
• Austerity packages to curb inflation and
current account deficit.
• Reforms in 1982–84
Effective in reducing deficits and
containing aggregate demand, but
impact short-lived.
1994–97 Plan to meet
Maastricht criteria
• Introduced multiyear framework.
Met Maastricht criteria. Difficulties in
controlling expenditures.
2003– 07
Consolidation
• Fiscal adjustment focused on expenditure
control; revenue-to-GDP ratios targeted to
remain stable.
Some expenditure slippages, partly offset
by one-off revenues.
1976–79 Plan
• Cut deficit by 2¾ percent of GDP.
Weak economic growth led government
priority to shift from fiscal adjustment to
stimulus.
1981–85 Plan
• Cut deficit by 1¼ percent of GDP.
Largely successful.
1991–95 Plan
• Cut deficit by 1½ percent of GDP.
Did not meet objectives.
2003–07 Plan
• Cut deficit together with “Agenda 2010”
structural reforms (labor market, pensions).
Largely successful.
Virage de la Rigueur,
1982–84
France
Objectives/Design
G-7 Fiscal Adjustment Plans
Country
Italy
Japan
United
Kingdom
Adjustment Plans
Objectives/Design
Comments/Outcome
1994 Economic and
Financial Program
Document (EFPD) for
1994–97
• Reduce the debt-to-GDP ratio beginning in 1996.
• Strong interest in joining EMU. Initial plan did not
aim at meeting Maastricht criterion of 3% deficit,
but objectives made more ambitious in mid-course.
2002 EFPD for
2002–05
• Planned for a 3 percent of GDP expenditure cut.
Attained lasting reduction in debtto-GDP ratio, albeit at high levels.
Maastricht criterion met through
last-minute efforts.
Revenue ratio remained
unchanged. Large expenditure and
fiscal balance overruns.
1997–Fiscal Structural
Reform Act
• Reduce deficit to 3 percent of GDP by FY 2003
Immediately derailed by Asian
crisis and domestic banking crisis.
2002– Medium-Term
Fiscal Adjustment
Plans.
Howe’s 1980 MediumTerm Financial
Strategy
Lawson’s 1984 Budget
• Aim for primary surplus by early 2010s.
• Introduced five-year rolling frameworks.
Partially successful in the initial
stages. Ultimately derailed by the
global crisis
Expenditure overruns in social
security, public wages, and support
to public enterprises.
Clarke’s November
1993 Budget
Darling’s 2007 PreBudget Report and
Comprehensive
Spending Review
• Curb government borrowing to rein in the money
supply and inflation. Envisaged 5½ percent of GDP
cut in the deficit.
• Rebalance the tax burden, shrink the state, and
reduce public sector manpower.
Expenditure cuts beyond what
was envisaged. Privatization of
large public enterprises.
• Eliminate the 8 percent of GDP deficit by 1998.
Delivered a steady reduction in the
fiscal deficit.
Derailed by global crisis: revenue
underperformance, expenditure
overruns, capital injections to
banks.
• Planned modest reduction in the deficit, by
reducing the growth of spending.
G-7 Fiscal Adjustment Plans
Country
United
States
Adjustment
Plans
Objectives/Design
1985 GrammRudman- Hollings
• President submit budgets consistent with GRH targets
each year, and balanced budget by 1991.
OBRA–1990
(Omnibus Budget
reconciliation Act)
• Reduce deficit by cumulative US$500 billion (equivalent
to 8.5 percent of 1991 GDP) in 1991-95.
• Introduced discretionary spending caps and pay-as-yougo (PAYGO) mechanism. Included some tax increases.
OBRA–1993
• Reduce the deficit by 1988 by 1¾ percent of GDP,
relative to the no-policy-change baseline.
• PAYGO continued and discretionary spending caps
extended, with five-year nominal spending freeze. Some
tax increases and measures to close loopholes.
Source: IMF staff compilations.
Comments/Outcome
Did not achieve targets but deficit
would have been larger in
absence of GRH.
Unable to restrain the unexpected
growth in spending for entitlement
programs (notably, Medicare and
Medicaid).
Deficit reduction well in excess of
targets, with stronger-thanexpected economic growth and
revenues, but also effective
spending caps.
Public Sector New Borrowing and Debt in the
U.K.
(In percent of GDP)
80
70
Howe's
1980
MTFS
Lawson's
1984
Budget
Darling's
2007
PBR + CSR
Clarke's
Nov. 1993
Budget
Net Debt (LHS)
60
Net Borrowing
(RHS)
14
12
10
8
50
6
40
4
30
2
20
0
-2
0
-4
75
76
77
78
79
1980
81
82
83
84
85
86
87
88
89
1990
91
92
93
94
95
96
97
98
99
2000
1
2
3
4
5
6
7
8
9
10
11
12
13
14
10
Key Findings
Findings in Three Dimensions:
1.
2.
3.
Rationale for and design of the envisaged fiscal
adjustment
Degree of implementation and underlying
macroeconomic factors
Political and institutional determinants of the
implementation record
Rationale for and Design of
Fiscal Adjustment Plans

Envisaged composition of fiscal adjustment:


Most plans focused on spending cuts, consistent with
the relatively large initial size of government,
particularly in Europe.
Macroeconomic assumptions:

Macroeconomic assumptions were mostly in line with
those of independent observers
Revenue and Expenditure Composition of 66 Plans
(In Percent)
Revenue
Expenditure
Increase
Decrease
Total
Increase
10
27
37
Decrease
0
63
63
10
90
100
15
Rationale for and Design of
Fiscal Adjustment Plans

Envisaged composition of fiscal adjustment:


Most plans focused on spending cuts, consistent with
the relatively large initial size of government,
particularly in Europe.
Macroeconomic assumptions:

Macroeconomic assumptions were mostly in line with
those of independent observers
Implementation Record and Underlying
Macroeconomic Factors

Implementation record and degree of ambition:



Revenue-expenditure mix in outcomes versus plans:


Evidence from study of 66 large adjustment plans in the EU
sample: it is “OK to plan big.”
Ambitious plans do tend to produce more adjustment than do more
modest plans, by a factor of one.
Expenditure cuts did not materialize to the extent envisaged.
Revenues compensated in part.
Key role of economic growth:

Deviations of economic growth from initial expectations were a
major factor underlying success or failure.
European Union: Planned and Actual Adjustments, 1991-2007
(Percent of Potential GDP)
y = 1.0959x - 0.8845
10
R² = 0.4095
Actual adjustment (Percent of potential GDP)
8
SE95
6
FI97
CY04
FI95UK95
UK97
HU05
4
UK93
LU05
PL04
BE92
FI99NL03
IT05 PT01
SE97
DE05
AT00 DE03
PT93
SE03
ES04
BE96
EL04
AT96
FR04
UK03 ES99
0 ES97
BE99
PT99
FR02
DE01
NL91
PT91 0
1AT05
2 CZ05
3
SL04
PT97
IT01 UK05 LT04IT03 PT03
EL92
PT05
2
-2
-1
IT97
-2
EL98
IT99
EL02
MT04
4
5
EL94
SK05
-4
EL00
-6
Planned adjustment (Percent of potential GDP)
6
Implementation Record and Underlying
Macroeconomic Factors

Implementation record and degree of ambition:



Revenue-expenditure mix in outcomes versus plans:


Evidence from study of 66 large adjustment plans in the EU
sample: it is “OK to plan big.”
Ambitious plans do tend to produce more adjustment than do more
modest plans, by a factor of one.
Expenditure cuts did not materialize to the extent envisaged.
Revenues compensated in part.
Key role of economic growth:

Deviations of economic growth from initial expectations were a
major factor underlying success or failure.
EU sample: Actual versus Planned Structural Fiscal Adjustment
(Percent of potential GDP; means reported, except for implementation
ratios, which are medians)
error = ∆ACTUAL
minus ∆PLAN
(0 is perfect
implementation)
Median implementation
ratio =
∆ACTUAL/∆PLAN
(1 is perfect
implementation)
∆PLAN
∆ACTUAL
0.1
1.0
0.9
0.5
Cyclical
0.2
0.5
0.3
1.2
Structural
-0.1
0.5
0.6
…
Expenditures
-2.3
-1.0
1.3
0.4
Primary
-1.8
-0.3
1.5
0.2
-0.5
-0.6
-0.1
1.0
1.7
0.9
-0.8
0.8
Revenues
Interest
Structural primary balance
Implementation Record and Underlying
Macroeconomic Factors

Implementation record and degree of ambition:



Revenue-expenditure mix in outcomes versus plans:


Evidence from study of 66 large adjustment plans in the EU
sample: it is “OK to plan big.”
Ambitious plans do tend to produce more adjustment than do more
modest plans, by a factor of one.
Expenditure cuts did not materialize to the extent envisaged.
Revenues compensated in part.
Key role of economic growth:

Deviations of economic growth from initial expectations were a
major factor underlying success or failure.
Baseline Regressions With Core Variables
Dependent Variable: Implementation error = actual minus planned adjustment
Fixed Effects
VARIABLES
Overall balance base effect
Initial fiscal balance
Real GDP growth surprise
Plan ambition
(1)
(2)
(3)
(4)
(5)
(6)
-0.61***
(0.17)
-0.26
(0.22)
0.34***
(0.059)
-0.37
(0.47)
-0.61***
(0.16)
-0.53**
(0.19)
-0.38
(0.24)
0.12
(0.13)
-0.29
(0.47)
-0.82***
(0.22)
-0.27*
(0.16)
0.52***
(0.088)
-0.29
(0.33)
-0.85***
(0.24)
-0.53***
(0.13)
-0.39**
(0.18)
-0.029
(0.079)
-0.29
(0.33)
Deviation of initial deficit from 3% of
GDP level
Time dummies
Observations
R-squared
FE Instrumental Variables
66
0.456
0.34***
(0.059)
-0.19
(0.32)
0.18
(0.18)
66
0.422
Yes
66
0.662
66
0.367
0.53***
(0.094)
-0.14
(0.29)
0.24
(0.19)
66
0.320
Yes
66
0.177
Robust standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1
22
Fiscal Institutions and Political Factors

Features influencing degree of implementation:
1.
2.
3.
4.
5.

Monitoring of fiscal outturns and policy response to data
revisions
Binding medium-term limits
Contingency reserves
Coordination across levels of government
Fiscal rules
Political Factors and Public Support for Fiscal
Adjustment:

Lower fractionalization in the legislative body and perceptions
of greater political stability are to some extent associated with
better implementation of plans.

Public support is crucial for implementation success.
Implications for Planned Adjustments

Spelling out how policies will respond to shocks.

Monitoring and accountability: Implementation of plans
should be supported by reliable and timely information.

The revenue-expenditure mix of fiscal consolidation plans
needs to reflect country-specific societal preferences and
structural fiscal characteristics.

Structural reforms underpin successful implementation of
large fiscal adjustment plans.

Build public support—public support for fiscal adjustment,
rather than a comfortable legislative majority, is what
matters.

Thank you!

To find out more: Chipping Away at Public
Debt—Sources of Failure and Keys to Success
in Fiscal Adjustment, Wiley.
Background Slides
Additional Regressions With Political Variables and Asymmetries
Dependent Variable: Implementation error = actual minus planned adjustment
FE Instrumental Variables
VARIABLES
Overall balance base effect
Initial fiscal balance
Real GDP growth surprise
Plan ambition
(1)
-0.82***
(0.22)
-0.27*
(0.16)
0.52***
(0.088)
-0.29
(0.33)
Positive overall balance base effect
Negative overall balance base effect
(2)
-0.27*
(0.16)
0.50***
(0.089)
-0.26
(0.32)
-0.92***
(0.34)
-0.71**
(0.31)
Positive growth surprise
(3)
(4)
(5)
(6)
-0.83***
(0.22)
-0.31
(0.19)
-0.84***
(0.21)
-0.39**
(0.16)
0.49***
(0.080)
-0.40
(0.32)
-0.68***
(0.21)
-0.30**
(0.13)
0.45***
(0.088)
-0.46
(0.28)
-0.87***
(0.22)
-0.30*
(0.17)
0.50***
(0.087)
-0.29
(0.34)
-0.33
(0.33)
0.37
(0.29)
0.58***
(0.16)
Negative growth surprise
Fiscal rule strength
0.61**
(0.30)
Change in government stability
3.07***
(1.12)
Parliamentary fractionalization
Observations
R-squared
Robust standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1
-3.62*
(2.09)
66
0.367
66
0.380
66
0.375
66
0.426
66
0.493
65
0.382
Regressions with Outliers Removed
Dependent Variable: Implementation error = actual minus planned adjustment
VARIABLES
Overall balance base effect
Initial fiscal balance
Real GDP growth surprise
Plan ambition
(1)
-0.70***
(0.20)
-0.14
(0.11)
0.38***
(0.056)
-0.0044
(0.19)
Positive overall balance base effect
Negative overall balance base effect
Fixed Effects
(2)
(3)
-0.13
(0.12)
0.37***
(0.049)
0.033
(0.21)
-1.64***
(0.47)
-0.46**
(0.18)
Positive growth surprise
-0.82***
(0.21)
-0.19
(0.11)
-0.076
(0.19)
(4)
(5)
-0.72***
(0.20)
-0.30**
(0.13)
0.34***
(0.048)
-0.26
(0.18)
-0.87***
(0.20)
-0.15*
(0.091)
0.54***
(0.092)
0.11
(0.16)
-0.14
(0.097)
0.52***
(0.090)
0.14
(0.16)
-1.69***
(0.47)
-0.64**
(0.25)
0.21**
(0.090)
0.48***
(0.066)
Negative growth surprise
Fiscal rule strength
-1.22***
(0.34)
-0.30**
(0.12)
-0.16
(0.20)
Parliamentary fractionalization
58
0.582
58
0.611
58
0.602
-0.85***
(0.18)
-0.30***
(0.10)
0.45***
(0.064)
-0.15
(0.15)
-0.087
(0.30)
0.82***
(0.23)
0.41*
(0.23)
2.68***
(0.82)
-0.47
(2.64)
Change in government stability
Observations
R-squared
Robust standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1
FE Instrumental Variables
(6)
(7)
(8)
57
0.713
0.38**
(0.16)
2.25***
(0.70)
-1.18
(1.67)
58
0.496
58
0.534
58
0.437
57
0.665
Advanced economies: Illustrative scenarios for primary
balance adjustment and debt
6
4
2
0
-2
Cyclically Adjusted Primary Balance
-4
Primary Balance
-6
-8
2007
2009
2011
2013
2015
2017
2019
2021
2023
2025
2027
2029
100
90
80
70
60
50
General Government Gross Debt – to – GDP ratio
40
30
2007
2009
2011
2013
2015
2017
2019
2021
2023
2025
2027
2029
29