(Version in Español)
The austerity vs. growth debate has raged in recent months, pitting those who argue that fiscal policy should be tightened more aggressively now to bring down high levels of debt, even though economic growth remains weak, against those who want to postpone the adjustment to better times. This is a critical issue for policymakers, perhaps the most important one in the short run.
This is bad for two reasons:
- The debate is driven, to some degree, by ideology and is therefore more focused on the relatively limited areas of disagreement than on the far broader areas of agreement. Most economists would agree that fiscal consolidation is needed in advanced economies, and that the average annual pace of adjustment during 2011-12―about 1 percentage point―is neither too aggressive nor excessively slow. Most economists would also agree that countries under pressure from markets have to adjust at a faster pace, while those that do not face such constraints have more time. Of course, there is disagreement on some aspects of the fiscal strategy, but it relates to specific country cases.
- The debate is detracting attention from policy issues that may seem less urgent, but which are nevertheless critical in the medium term. I am referring to what I would call the institutional gaps in fiscal policymaking that still exist in most advanced and emerging economies. These gaps have contributed to a bias in the conduct of fiscal policy in favor of deficits that is behind many of the current problems.
The deficit bias
Since the collapse of the Bretton Woods system of fixed exchange rates in the early 1970s, it has been pretty obvious that there is a bias in favor of increasing public debt levels. Even before the global economic crisis hit in 2008, the average public debt-to-GDP ratio for advanced economies was at its highest level ever during the past 130 years, surpassed only by the Second World War.
On average, the public debt-to-GDP ratio increased from 29 percent in 1974 of GDP to 74 percent of GDP in 2007. During this period, the debt ratio surged during bad times but did not decline in good times. In some countries where public debt appeared to be low before the crisis (examples include Iceland, Ireland, Spain and United Kingdom), no consideration had been given to the exposure of these countries’ fiscal accounts to large risks linked to the size of their financial sector and revenues that were boosted by factors that turned out to be transitory.
In emerging economies, fiscal accounts currently appear to be in reasonably good shape. This group of countries has been growing at unprecedented rates for almost a decade (with the brief exception of 2009), and many have benefitted from high commodity prices. And yet, 40 percent of them (representing some 60 percent of emerging market debt) still has a debt-to-GDP ratio exceeding the 40 percent threshold that is often considered prudent for this country group. In many of these economies, financial repression (the use of various measures to channel funds to the government) is still used to facilitate the financing of public debt.
Plugging the gaps
In order to overcome the bias in fiscal policymaking in favor of deficits, several institutional gaps need fixing. They relate to:
- budgetary processes that are too focused on the short term
- a lack of transparency in fiscal accounts
- inadequate comparability of information across countries
- governance issues
Let me address each in turn.
Planning for the future
In most countries, the budgetary process is essentially a short-term (annual) business. In the United States, for example, which faces severe―and largely unaddressed―medium-term fiscal challenges, much more progress is needed in establishing a binding multi-year budgetary framework.
But the focus on the medium term is lacking in several other countries as well. While medium-term forecasts are prepared in many countries, they do not really constrain policy decisions in any meaningful way. The result is a focus on short-term developments, rather than underlying trends, which often implies a bias towards procyclical policies during high growth periods, and insufficient attention being given to long-term spending pressures, such as those related to age-related spending.
This short-termism also hampers policy planning. For instance, spending reviews aimed at assessing the medium-term effectiveness and financial impact of certain government policies are still absent even in advanced economies―Italy, for example, is only now moving more forcefully in this direction. Budgeting is also too focused on cash, rather than accrual, measures, which again often implies a short-term bias.
Being open and transparent
Transparency is far from adequate. Hidden fiscal imbalances have emerged in some European economies (Greece and Portugal come to mind), with negative consequences for the credibility of policymaking in these countries. Spain announced it would miss its fiscal deficit target by over 2 percentage points at end-2011. Public debt in China was recently revised up by 17 percentage points of GDP, owing to previously unrecorded local government debt. And there are many more examples.
One key issue is data coverage: less than half of the IMF’s 188 member countries publish fiscal data beyond the central government, and few publish comprehensive information on public enterprises. The frequency of information is also inadequate. Monthly data are scarce, quarterly data often unreliable. Only seven countries publish fiscal risk assessments, thus preventing a full appreciation of the exposure to shocks. Very few publish balance sheet data on assets and liabilities.
No private firm would be allowed to operate, let alone issue securities, with such a limited degree of transparency.
Comparing apples and oranges
International comparisons of fiscal trends are hampered by idiosyncratic accounting and budgetary practices. There are well-established accounting standards for private firms. Standards have been developed for the public sector too, but most countries do not pay much attention to them. In the European Union, a directive was issued only last year to bring some order to government accounting, and even then, it was framed in fairly general terms.
International statistical standards also exist (including the Government Financial Statistics Manual of the IMF), but they are not adhered to closely. For example, countries report widely varying definitions of financial assets held by governments. Gross debt definitions are also inconsistent. For example, Japan does not net out intra-governmental debt holdings in its general government debt figures, as most other countries do.
The IMF has recently intensified its efforts to publish a fully harmonized definition of government debt—an initiative which over time will have to be broadened to other statistics.
Checks and balances
Finally, there is the issue of governance―who is in charge of making decisions about income and expenditure. This is a delicate issue. Surely the approach followed for monetary policy—giving unelected officials the ultimate control of key policy decisions—is impossible for fiscal policy. Fiscal policy decisions redistribute income both across groups of citizens and across generations. As such, they must be taken by parliaments.
However, more progress must be made in allowing for an assessment of fiscal policy trends, risks and policies by independent agencies―often referred to as fiscal councils. One example that comes to mind is the Fiscal Policy Council in Sweden, but there are others.
The introduction of fiscal councils has been encouraged in the euro area by the reform of the Stability and Growth Pact and is a requirement under the recently signed intergovernmental Fiscal Compact. But fiscal councils are still relatively uncommon, particularly in emerging economies, with a recent remarkable step backwards in at least one prominent case in emerging Europe.
If the gap is not closed . . .
The importance of fiscal institutions was discussed recently at a conference in Stockholm organized jointly by the Swedish Ministry of Finance and the IMF. During the final panel, Eric Leeper of Indiana University underscored that there is a gap between our knowledge of the way fiscal policy works and the way monetary policy works. He is right.
But equally important is the gap that exists when it comes to fiscal and monetary institutions.
If this gap is not closed, the deficit bias will persist. We risk seeing debt stabilize at new record-high levels, and not being brought down to more manageable levels once the good times are back. Their exposure to shocks will thus be even higher than it was in 2007.