Download What is at stake in fiscal rules

Fiscal Rules and Public
Debt Sustainability
Christophe Schalck
Bank of France
IBFI International Seminar
March 27th, 2007
1
Fiscal Policy Rule: permanent constraint on fiscal
policy expressed of a summary indicator of
fiscal performance.
Plan
1. What is at stake in fiscal rules
2. Fiscal rule components
3. Various fiscal rules in developed countries
4. Effectiveness of fiscal rules
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1. What is at stake in fiscal rules
1.1. Public finance sustainability
90
Fig 1. Public Debt (% GDP)
2
Fig 2. Fiscal stance (% GDP)
1
80
0
70
-1
60
-2
-3
50
-4
40
-5
30
-6
80 82 84 86 88 90 92 94 96 98 00 02 04
OECD
USA
ZE
80 82 84 86 88 90 92 94 96 98 00 02 04
OECD
USA
ZE
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Sustainability risks:

Snowball effect: leads to self sustainability growth of debt
generated by successive deficits and interest expense.

d t h
t h
h 0 (1   )
bt   Et 

No flexible: excessive debt makes economic policy less
flexible in the short run.

Fiscal distortions: fiscal measures can modify individual
behaviour and economic equilibrium.

Intergenerational equity: beneficiary agents are different
from financing agents.
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New indicators of sustainability:
European indicators taking into account future contingent liabilities tied
to age-related spending.
 S1: differences between the average tax ratio required to generate
debt ratio equal to 60% in 2050;
 S2: average primary balance required to equalize the present
discounted value of all future primary balances to the current gross
public debt.
Debt in
2005
Debt in
2050
S1
France
66.6
239
Germany
66.7
United Kingdom
S2
Initial
Position
Age
Total
3.2
1.4
2.6
4.0
261
3.5
1.6
2.8
4.4
42.8
239
3.4
1.8
3.2
4.9
Euro area
70.0
196
2.3
0.2
3.5
3.3
Eu 25
63.0
180
2.1
0.3
3.0
3.4
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1.2. Credibility of macroeconomic policies



Establish credibility of fiscal policy:
 Reduce deficit bias of governments (Buchanan &
Wagner, 1977);
 Fiscal policy can be time inconsistent (Kydland &
Prescott, 1977);
Managing of policy-mix: avoid conflicts of interest
between monetary and fiscal policies.
Role of financial markets: an excessive debt implies
 high risk premium;
 Changes in the credit ratings.
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2. Fiscal rules components
2.1. Criteria for an ideal fiscal rule
Kopits and Symansky (1998) have identify the desirable
features of an ideal rule:

Well-defined; Simple; Transparency; Flexible; Adequate;
Enforceable; Consistent; Efficient;
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2.2. Designing effective fiscal rules


Statute: Constitution, Law, Treaty
Target:

Fiscal balance (actual or primary).
 Cyclically-adjusted balance: allows automatic stabilizers to play their role.
But target is unobservable and subject to margins of interpretation.
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
Fiscal balance excluding public investments: so called golden rule.
Takes into account that public investments are productive spending,
hence investments increase potential growth.
 Implementation: Total or partial coverage a risk of expenditures
transfers.

Level of government:



The autonomous approach: subnational governments are large and
desire to maintain favourable credit rating.
The coordinated approach: top-down approach to ensure a degree of
fiscal discipline.
Sanctions: juridical, financial or loss of reputation.
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10
3. Existing fiscal rules
The United States
Year
1990 à
2000
Fiscal Rule
Budget Enforcement Act
Rules
Medium-term nominal caps for discretionary spending.
Legislated changes to revenues or mandatory spending programmes should be
budget neutral over a five-year horizon.
Enforcement/Sanctions
Sequestration procedures (cuts across-the-board).
Escape clause
“Emergency appropriations” could be passed.
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EU countries
1992
1997
2005
the Stability and Growth Pact
Rules
3 per cent of GDP ceiling on general government net borrowing.
60 per cent of gross government debt-to-GDP ratio norm.
medium term objectives in structural terms
Enforcement/Sanctions
Non-remunerated deposits with a fixed component equal to 0.2 per cent of deficit
and a variable component rising with size of excessive deficit.
Financial sanction applies only in case of non-respect of deficit rule, although peer
pressures can be exerted in the form of policy recommendations on the basis of the
Commission’s assessment.
Escape clause
Exceptional circumstances
Transparency
Member States are required to report twice a year to the Commission their planned
and actual deficits and their debt levels under the excessive deficit procedure. Once
a year they must also submit a stability programme.
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The United Kingdom
1997
Code for Fiscal Stability
Rules
Golden rule: over the business cycle the Government will borrow only to invest
and not to fund current spending.
Sustainable investment rule: net debt as a proportion of GDP must be held stable
over the business cycle at a prudent level defined so far as net debt below 40 per
cent of GDP.
Enforcement/Sanctions
No explicit sanctions.
Transparency
Annual reporting cycle, including a Pre-Budget Report, an Economic and Fiscal
Strategy Report and a Debt
Management Report.
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Spain
2003
Fiscal Stability Law
Rules
Accounts should balance or show a surplus at all levels of government (central,
social, territorial and local) as well as for public enterprises and corporations.
A cap will be put on expenditure and a contingency fund (2 per cent of expenditure)
will be set up to cover unscheduled expenditure.
Escape clauses
Possibility of running deficits restricted to temporary and exceptional situations.
Two-to-three-year plans to restore the accounts to balance will have to be discussed
in Parliament.
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4. Effectiveness of fiscal rules
4.1. Public finances performances
UK (% GDP)
USA (% GDP)
80
2
60
70
1
50
60
0
50
40
6
4
2
-1
40
-2
30
0
-2
-3
30
-4
20
20
-5
10
10
-6
0
-7
1990
1992
1994
1996
1998
2000
debt
deficit
2002
-4
-6
-8
0
-10
1990
2004
1992
1994
1996
Debt
France (% GDP)
1998
2000
2002
2004
Deficit
Spain (% GDP)
80
0
70
-1
70
-2
60
-3
50
60
50
40
-4
30
80
2
1
0
-1
-2
-3
-4
-5
-6
-7
-8
40
30
-5
20
20
10
-6
10
0
-7
0
1990
1992
1994
1996
debt
1998
2000
deficit
2002
2004
1990
1992
1994
1996
debt
1998
2000
2002
2004
deficit
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Results can come from economic environment. Thus a second
approach consists in studying the cyclically-adjusted primary balance
(capb).
USA capb
UK capb
4
4
3
3
2
2
1
1
0
0
-1
-1
-2
-2
-3
1990
-3
1992
1994
1996
1998
2000
2002
2004
-4
1990
1992
1994
France capb
1996
1998
2000
2002
2004
Spain capb
3
2
2
1
1
0
0
-1
-1
-2
-2
-3
1990
1992
1994
1996
1998
2000
2002
2004
-3
1990
1992
1994
1996
1998
2000
2002
2004
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Fiscal adjustments should be based on a reduction of public
expenditures and not on an increase of revenues (Alesina and Perotti,
1997)
37
43
36
42
35
41
34
40
33
39
32
38
31
1990
1992
1994
1996
1998
USA_G
2000
2002
2004
37
1990
1992
1994
USA_R
1996
1998
UK_G
52
2000
2002
2004
2002
2004
UK_R
41
40
51
39
50
38
37
49
36
48
35
47
1990
1992
1994
1996
1998
FRA_G
2000
2002
FRA_R
2004
34
1990
1992
1994
1996
1998
ESP_G
2000
ESP_R
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
Financial sustainability demands structural reforms:



Labour market reforms were pushed through to create added
flexibility and improve training opportunities.
Set up reserve funds and pension system reforms improving the
viability of the publicly-funded pillar.
For a fiscal rule to be successful, there must be a
national consensus.
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4.2.Macroeconomic stability performances

The economic literature show that level of cyclical
responsiveness has been reduced by fiscal rules.

To identify the behaviour of governments facing business
cycle and debt accumulation.
st   1   2  ayt  bd t 1   t



Positive a’s denote counter-cyclical policy;
Positive b’s denote sustainable policy.
Results can differ according to the fiscal balance which is selected.
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Dynamic approach
0.5
0.4
1
0.3
0.8
at
at
0.2
0.6
0.1
0.4
0
0.2
0
1967:1
-0.1
1972:2
1978:1
1983:2
1989:1
1994:2
2000:1
-0.2
1973:1
2005:2
1978:2
1984:1
semester
1989:2
1995:1
2000:2
2005:2
1995:1
2000:2
2005:2
semester
0.8
0.8
0.7
0.6
0.6
0.5
0.4
at
at
0.4
0.2
0.3
0.2
0
0.1
0
-0.2
-0.1
-0.4
1974:1
1979:2
1985:1
1990:2
semester
1996:1
2001:2
2005:2
-0.2
1973:1
1978:2
1984:1
1989:2
semester
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Thank you for your attention
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