International Experience with Rules-Based Fiscal Frameworks: Design Issues George Kopits Fiscal Council Republic of Hungary Conference on Fiscal Frameworks Mishkenot Shanamin Jerusalem, May 5, 2009

Outline Background RFF: key elements Policy rules, procedural rules Transparency Enforcement Country experience Performance

Background Discretionary policy: problems Time inconsistency Free rider, common pool problem Deficit bias Procyclical bias Expenditure composition bias Unsustainable public debt

Background Discretionary policy: economic effects Domestic imbalance (inflation, crowding out) External imbalance Macroeconomic volatility Low growth rate Financial crises (currency, bank, debt crises)

Key Elements of RFF Policy (numerical) rule: permanent constraint on a summary fiscal indicator Procedural rule: supporting regulation on budget process Transparency: functional, coverage, time horizon, accounting practices Enforcement: surveillance, sanctions for non-observance

Types of Policy Rules Budget balance rules overall balance (incl. deficit limit, min. surplus) current balance (“golden rule”) primary balance operating balance medium-term, structural, or CA balance

Types of Policy Rules Expenditure rules primary expenditure limit discretionary expenditure limit wage expenditure limit

Types of Policy Rules Debt rules debt ratio limit target debt ratio  primary surplus ratio real debt limit  nominal primary surplus

Types of Policy Rules Debt rules derive target primary surplus ratio Brazil: convergence to target debt ratio given target debt ratio derive target primary surplus ratio

Types of Policy Rules Debt rules Hungary: real debt limit given debt target derive primary surplus target and nominal surplus target (discretionary component)

Major Types of Procedural Rules medium-term budget planning pay-go principle for budget proposals limit on end-year carryover of appropriations rules on supplementary appropriations

Transparency (wide access to timely information) broadest coverage of public sector accounting for extra-budgetary operations accounting conventions (accrual vs. cash) forecasts (incl. realistic macro assumptions) institutional clarity (e.g., government functions, goals; intergovernmental relations, transfers) contingent liabilities, risk assessment

Enforcement Mechanism statutory basis: constitution, law, guidelines implementation: ex ante targets, ex post realization escape clauses, contingency funds surveillance: self, independent authority, other sanctions: reputational, legal, financial

Criteria for Success well-defined set of rules transparency simplicity adequacy to accomplish objective consistency, internally and externally flexibility with respect to shocks enforceability efficiency (that is, no distortionary effects)

Selected Country Practices

Experience: Compliance Good compliance: New Zealand, Brazil*, Bulgaria, Chile, Estonia, Norway, Peru,* Sweden, Canadian provinces, Swiss cantons, some Euro members Mixed compliance: Colombia,* Poland, Euro area (incl. national rules), UK, US states Poor compliance: Argentina,* Ecuador,* Venezuela* Promising start: India,* Switzerland, Mexico, Nigeria,* Hungary*

Experience: Performance In complying countries investor confidence moderate real interest rates relatively low inflation above-average growth, stability lower vulnerability to crises fiscal sustainability mixed results on external balance

Experience: Performance In complying countries Creative accounting ? rarely, not significant Pro-cyclical effects ? in some cases where initial structural deficit, high debt ratio, or postponed reforms Stop-gap measures or reforms ? in some cases compliance through distortionary measures (composition bias), where reforms postponed

Experience: Summing Up Mostly recent experience and “jury is still out” Basic tests: compliance over a full economic cycle and political cycle performance compared to counterfactual Identification problem, when applied in tandem with monetary rules (inflation targeting, fixed XR) On balance, experience has been positive