1. 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

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

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

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

5. 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

6. 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

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

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

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

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

11. 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

12. 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

13. 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

14. 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)

15. Selected Country Practices

16. 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*

17. 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

18. 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

19. 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