Fiscal Discipline
Charles Wyplosz
The Graduate Institute, Geneva
Conference on Fiscal Policy
IMF, 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
60
50
40
30
20
1970
1975
1980
1985
1990
1995
2000
2005
Fiscal discipline is hard to come by
Latin America
60
55
50
45
40
35
30
25
20
15
10
1970
1975
1980
1985
1990
1995
2000
2005
Fiscal discipline is hard to come by
Asia
70
65
60
55
50
45
40
35
30
25
20
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
80
70
Convergence
EMU starts
60
50
EMU
Non-EMU OECD
40
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
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
Chile
Switzerland
50
60
40
50
30
20
40
10
0
30
1990
1992
1994 1996
1998
2000
2002 2004
2006
2008
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
90
80
Note:
Rules often
established after
debt reduction
70
60
50
40
1990
1992 1994
1996
1998 2000
2002
2004 2006
2008
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
80
70
60
50
40
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