1. Fiscal DisciplineCharles WyploszThe Graduate Institute, GenevaConference on Fiscal PolicyIMF, 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

4. Fiscal discipline is hard to come by

5. 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

19. 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