1. Fiscal adjustment in EU countries: A Balance Sheet Approach Gian Maria Milesi-Ferretti Kenji Moriyama International Monetary Fund

2. Motivation Debate on the design of fiscal rules and reforms of the SGP Frequent adoption of ‘creative accounting’ measures Proposals to move fiscal accounting towards a ‘balance sheet approach’ (e.g., new GFS manual) or to exclude investment from deficit calculations (e.g., new GFS manual) or to exclude investment from deficit calculations

3. What the paper does Sketches government balance sheet Defines “cosmetic” (nonstructural) fiscal measures Provides examples Presents empirical evidence on the evolution of net worth in EU countries up to 1997 and thereafter

5. A balance sheet approach Stocks: AssetsLiabilities Public capitalGross financial liabilities Gross government debt Debt held by publ. inst. Other Gross Financial assets

6. A balance sheet approach (contd) Flows: Change in net worth= Flow change in financial assets - Flow change in financial liabilities + Net public investment + valuation effects

7. Key issue Valuation of public capital –Market value (desirable) –Book value (feasible) Financial returns on public capital lower than on public debt

8. Intertemporal budget constraint W(t)=net worth G(t)=government spending T(t)=government revenues

9. ‘Cosmetic’ measures Measures that improve the fiscal balance and/or reduce gross government debt.... But do NOT reduce the present value of future taxes needed to finance future spending and repay existing debt

10. Examples of ‘cosmetic’ measures Sale of public assets Securitization operations Capital injections and recapitalization Off-budget items Quasi-fiscal activities

11. Change in government balance sheets: key questions Did fiscal rules lead to “fiscal adjustment”? Are changes in government debt improving net worth? Which countries have relied more heavily on sales of public assets?

12. Empirical approach Collection of data on ‘cosmetic’ measures difficult to undertake Hence indirect approach: compare “Maastricht variables” with dynamics of net worth

13. Limitations of approach Misses reforms that alter future taxes and spending (e.g.: pension reforms) Large measurement problems Symmetric reductions of public assets and liabilities may be desirable (e.g.: privatization)

14. Political economy insights “creative accounting” measures more likely when rules are more stringent Optimistic forecasts more likely when governments discount the future more heavily

15. Change in public assets and initial debt, 1992-97

16. Change in public assets and liabilities, 1992-97

17. Changes in net worth and changes in liabilities, 1992-97

18. Change in public assets and liabilities, 1997-2002

19. Changes in govt liabilities and net worth, 1997-2002

20. Growth forecast and budget balance

21. Summary of findings 1992-1997 Changes in financial liabilities reflect primarily changes in public assets; 1998-2002 Change in financial liabilities reflect primarily changes in net worth Governments with more serious fiscal problems tend to be more optimistic than markets about growth prospects

22. Conclusions Fiscal rules can be helpful... But it is important to understand the incentives they set in place.......and monitor fiscal developments more broadly