1. Fiscal Discipline Charles Wyplosz The Graduate Institute, Geneva Conference on Fiscal Policy IMF, June 2, 2009

2. Outline  Fiscal discipline is hard to come by  Institutions matter  Rules are arbitrary  Bureaucrats are great but unwelcome  How to affect politicians’ incentives?

3. Fiscal discipline is hard to come by

6. 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

7. 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

8. 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

9. Fiscal rules Formal budget rules  Stability Pact Numerical deficit ceiling (3% rule) External monitoring and sanctions Some effect, maybe

10. Stability pact effect

11. 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

12. Fiscal rules Formal budget rules  Stability Pact  Swiss “brake”  Chile and structural budget rule Similar to Switzerland

13. Swiss brake

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

15. Sweden Note: Rules often established after debt reduction

16. 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

17. 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)

18. The Dutch medium-term framework

20. Fiscal rules Formal budget rules Informal budget rules Inherent arbitrariness  Deficit vs. debt  Gross, net, contingent liabilities  Deficit/debt vs. spending

21. 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

22. 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

23. 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?

24. Conclusions Affect incentives  Can be evolutionary The Dutch approach  Technical skills The Wisemen approach  Independence Europe’s special case  Replacing the Stability Pact