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

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

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

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

Sweden Note: Rules often established after debt 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

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