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An Analytical Framework With Application
Deficits: Definitions and explanations Fiscal sustainability. What do you want to
call fiscal balance? How should fiscal policy look like in
theory? How does it look in practice?
Different concepts of Deficit Full-employment (structural) deficit
Note that the deficit varies with the business cycle Revenues are greater in expansions Expenditures are greater in recessions
What would the deficit be if we leave aside these cyclical fluctuations?
In a recession, structural deficit is lower than overall deficit
Primary deficit Net of interest payments:
Some of the current deficit is simply interest on previously accumulated debt
Credit card again: regardless of what you do this month, you still have to pay interest on your balances
On-Budget and Social Security Balances
-8 .0 %
-6 .0 %
-4 .0 %
-2 .0 %
0 .0 %
2 .0 %
4 .0 %
6 .0 %
Ye a r
% o
f G
DP
On BudgetBalance
Soc ialSecurityBalance
S o urc e : E c o no m ic R e p o rt o f the P re s id e nt
Stabilization Fiscal Policy as a tool to manage AD in the short run Example: Tax cut But recall our discussion on the multiplier: What if
people look ahead and see that the extra deficit will have to be paid for at some point (with interest!)?
This is often called the “Ricardian” view “Tax Smoothing”
Even if deficits have no impact on AD, it may still be the case that you want to run them
Taxes have a distortive impact on incentives (i.e. they can affect AS) The distortion is greater at higher rates
If you have temporary need for high spending, you want to borrow instead of raising taxes
US Federal Budget (% GDP)
Source: Economic Report of the President
Country averages, 1999-2007 (2008 where available)
Deficits : Thinking about The Future Burden
Borrowing If the government needs to incur some expenditure
beyond current revenues, it can issue a bond and sell it to the private sector
In other words, it borrows money from the private sector, and pays interest on it
Ex: In the US, government can issue Treasury bill (to be paid back in one year or less), T-note (two to ten years), T-bond (twenty to thirty years) T-note and T-bond pay interest (“coupon”) every six
months; T-bill pays no explicit interest, but is sold at a discount
These bonds are also traded in secondary markets (that’s where the Fed conducts open market operations)
Monetizing In principle, the government can also sell
these new bonds to the Central Bank To buy them, the CB “prints money” This form of raising revenue for the
government is called “seignorage” This is a way in which FP can influence MP Independence of the Central Bank is meant
to prevent this type of process
Current Outlook Right now, most developed countries are running
very high budget deficits To a large extent, this is a product of the recessions However, there are structural issues that, if
unaddressed, may lead to structurally high deficits, and consequently to increasing (possibly unsustainably so?) debt levels
Demographic issues Aging Pensions / Health expenditures Fewer workers to tax to pay for that Less private savings (older people save less)
A lot of these are off-budget items
What Is “Unsustainable”? Ultimately, it’s about the country’s perceived ability to repay If investors think they won’t be repaid, they won’t buy bonds
Look at Greece right now If debt relative to GDP is too high (and rising), the ability to
repay may be a concern But how high is “too high”? That depends a lot on the situation of each country!
Debt is accumulated in order to fund a fiscal deficit
The fiscal deficit can be decomposed into three components
Deficit = G – T + i D Primary spending Current revenues Interest on the debt
We do not consider debt issuance or privatization as revenue or debt amortizations as spending
We call T – G the primary surplus, S Deficit = i D - S The deficit is just equal to the increase in net debt
SiDDeficitdt
dD
An unsustainable position is one where the debt rises faster than the capacity to pay for it
For debt to be sustainable in the long run, some ratios have to be stable Debt to GDP Debt to tax revenue
What needs to be the fiscal balance for this to occur?
ttt
tt sb
g
rb
11
1Consider the following law of motion
Where b is the debt to gdp ratio, r is the nominal (real) interest rate, g is the nominal (real) rate of gdp growth and s is the primary surplus.Then b(t) = b(t-1) if:
bg
grs
1
A typical tax revenue ratio for an LDC is 15-20 percent
A typical real growth rate is 3-4 percent A typical debt ratio is 40% of GDP A typical real interest rate is 5% The equation implies that the primary
surplus needs to be s=(.05-.03).4=0.8% So if T/Y = 15%, then G/Y =14.2%
Rank2002 1995 2002 1995 2002 1995 2002
Turkey 1/ -19.2 -5.8 81.2 42.8 4.0 3.9 1Argentina 1/ -12.8 -3.2 174.0 38.3 0.3 -1.3 2India 2/ -10.2 -6.9 80.6 71.0 -4.0 -1.9 3Hungary -9.5 -6.2 49.9 84.3 -5.5 2.7 4Philippines 1/ -8.3 -4.2 99.4 80.5 2.3 80.5 5Brazil 1/ -4.7 -7.0 95.1 31.1 4.0 0.3 6Indonesia 3/ -1.8 0.8 80.6 29.0 3.8 2.6 7Chile 1/ -1.4 3.3 20.9 20.0 -1.1 4.2 8South Africa 3/ -1.2 -5.6 39.9 42.2 3.0 -1.0 9Ecuador 1/ 0.8 -1.2 57.8 39.7 4.4 2.9 10Russia 0.7 -6.5 34.7 37.9 2.8 -2.7 11
Source: WEO.
1/ Public sector.2/ For India gross debt.3/ Central government.
Table 1: India's General Government Finances in an International Context
General Government
(In percent of GDP)
Debt-to-GDP 1/Deficit-to-GDP Primary Deficit-to-GDP
*
*
eYY
eBBb
Consider the debt ratio
Where B* is debt in dollars (tradables) and Y* , Y is tradable and non-tradable output
1
1
)1(
*
1
eP
P
PP
P
P
EPq
PPP
N
T
NT
T
NT
**
**
eBBeYY
BYYBe
b
e
e
b
The elasticity of b relative to e is given by:
Table 22
Year b B/eB* Y/eY* Elasticity
El Salvador 1998 0.27 0.00 3.03 0.75
Argentina 1998 0.38 0.08 8.63 0.82
Brazil 1998 0.42 1.76 12.34 0.29
Ecuador 1998 0.67 0.02 2.94 0.73
Colombia 1998 0.22 0.59 6.36 0.49
Chile 1998 0.12 1.30 2.85 0.18
Source: Own calculationsNote: b: Total Public Debt/GDP
B*: Debt denominated in terms of tradablesB: Debt denominated in terms of non-tradablesY: Non-tradables GDPY*: Tradables GDP (proxied by exports)
Public Sector Debt Mismatch Measure
Fiscal policy as business-cycle management
Spend in bad times, save in booms Use fiscal policy when monetary policy is
ineffective Liquidity trap Japan
Problem: suffers from long and variable lags, but also slow to decide and difficult to change The problem with the shower temperature
People have expectations about the future The do not see debt as net wealth, since it
will be serviced with their own taxes Ricardian equivalence: an increase in
public spending is an increase in future taxes, leading the private sector to spend less in the present
Useless from the point of view of demand management
Two periods, no discount rate, r=0 i=0, rate of discount = 0 Government consumes always the same
amount but taxes only in period 2 G1=G2=G
Private income is given, Y1, Y2 2G= t * Y2 Y1+(1-t)Y2=C1+C2 U=u(C1)+u(C2) C1= C2= [Y1+(1-t)Y2]/2 = [Y1+Y2]/2-G dC1/dG = -1
Distortionary taxes Y=Y(t), Y’<0, Y’’<0 E.g. Y1 = Y – at2
Budget constraint of govt G1+G2=t1*Y1 + t2 * Y2 (1-t1)Y1+(1-t2)Y2=C1+C2 U=u(C1)+u(C2) C1= C2= [(1-t1)Y1+(1-t2)Y2]/2 At the optimum t1 = t2
Imperfect capital markets in dev. countries Off-set coefficient: how much does private
saving increase when public saving declines? Standard estimates at 0.5 (Edwards 1996) But only because of crisis times (Gavin 1997)
In normal times offset is very high It is very low in bad times
Overlapping generations I get the money, my children pay the taxes
Exploiting non-equivalence is a weak basis for policy Tell it to the Republicans
Y may be volatile because of supply and demand shocks
G may be volatile because programs may have uncertain costs
T depends on Y G may also depend on Y, ideally with a
negative correlation Unemployment compensation
Automatic stabilizers can do the trick
Optimal policy: stabilize tax rates in an inter-temporal program that is solvent
How does it look like? Run deficits in periods of low income Run surpluses in periods of high income Make sure that debt ratios remain stationary
Looks keynesian. What is the difference?
The OECD calculates the full-employment deficit They calculate what would have been the
deficit if the economy was at the equilibrium Y Is this appropriate for developing
countries?
The terms of trade may be at non-equilibrium levels The current account may be at non-equilibrium
levels Since there is taxation on spending and imports, this may
generate a difference of income vis a vis equilibrium The real exchange rate has important fiscal
implications Calculate FD at equilibrium RER
Are interest rates at equilibrium levels? Domestic rates and the “peso problem” Foreign rates are volatile Old debt may be at different rates than current rates
“Structural fiscal deficit” is where the FD&BB curve cross the NN curve
-30%
-20%
-10%
0%
10%
20%
1 2 3 4 5 6 7 8 9 10 11 12 13 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
recessions
Cummulative GDP fall (%) Change in fiscal surplus (% del PIB)
Fiscal balance during recessions
OCDE América Latina
-0.2
-0.1
0.0
0.1
0.2
0.3
0.4
0.5
0.6
Fiscal Balance Public Consumption Inflation tax
América Latina OCDE
Correlation coefficient with GDP; 1970-95
0%
5%
10%
15%
20%
25%
30%
35%
Fiscal shock Revenues Current spending Capital expenditures
OCDE América Latina
Volatility of fiscal variables; 1970-94(Standard deviations of the rates of growth)
200
400
600
800
1000
1200
Jan
-97
May
-97
Se
p-9
7
Jan
-98
May
-98
Se
p-9
8
Jan
-99
May
-99
Se
p-9
9
Jan
-00
May
-00
Se
p-0
0
Jan
-01
May
-01
Se
p-0
1
776 pb
The cost of borrowing is volatile(LEI, Spread over US Treasuries)
Pre-Asian Crisis
Pre-Russian Crisis
Pre-Argentine Crisis
Current level
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
Pro
-cyc
lical
ity
of
go
vern
men
t co
nsu
mp
tio
n
1% 2% 3% 4% 5% 6% 7%
Volatility of GDP growth
ARG BRBBOL
BRACHL
COL
CRI
DOMECU
GTM
HND
JAM
MEX
PANPRY
PER
SLV TTOURY
VEN
CAN
FRA
DEU
ITAJAP
GBRUSA
Volatility of GDP growth andPro-cyclicality of government consumption
1970-95
-1.5
-1
-0.5
0
0.5
1
1.5
Per
cent
of G
DP
Fiscal Outcome
Pre-election Election year Post-election
Fiscal Policy and ElectionsLatin America, 1980-96
Why do developing countries face precarious access to borrowing? Do they borrow too much? Do they tax too little?
Why do they exhibit pro-cyclical instead of anti-cyclical fiscal policy?
Why is there an electoral budget cycle?
Coordination problems The common pool problem Delayed stabilization
Aggregation problems Arrow’s impossibility theorem Electoral rules
Agency problems Credibility/time-inconsistency problems
Chicken and lobster While their benefits tend to be concentrated,
they tend to be financed from a common pool of resources (Weingast, Shepsle and Johnsen 1981)
The budget is the result of a collective decision-making process, involving a variety of agents: Legislators Spending ministers The finance minister
Generates a tendency to overspend and to overborrow
Dynamic version Tendency towards pro-cyclical spending
Delegated choice, incompatible objectives and asymmetric information
Governments may want to spend more money than the public, because they can appropriate part of it
Lack of confidence Incentives to lie about real situation
Incentives to distort reality through policy E.g. The electoral budget cycle (Nordhaus
1975, Tufte 1978, Rogoff 1990)
What is optimal today is not optimal tomorrow Let bygones be bygones
Promise to repay in good times is not credible Imperfect credibility leads to undereborrowing
in bad times Signalling (Saint Paul)
Whose choice is it? Down to West Palm Beach
Proportional representation vs. first past the post District magnitude Margaret Thatcher’s landslide?
What are the costs and benefits Better representation vs. more difficult
aggregation Effective number of parties One or two chambers?
0 4 8 12 16 20
BahamasTrinidad
HaitiBarbados
JamaicaBelize
PanamaChile
EcuadorDom RepParaguay
PeruColombiaSurinameUruguay
GuatemalaHondurasNicaragua
Costa RicaEl SalvadorVenezuelaArgentina
BoliviaMexico
Brazil
Representatives per electoral districtLower chamber
Guyana ha sido excluída del gráfico por razones de presentación. Su número de representantes es 43.4.
1
10
Nú
me
ro d
e P
art
ido
s E
fec
tiv
os
1 10 100 1000
ARG
BHS
BLZ
BOL
BRA
BRB
CHL
COLCRIDOM
ECU
GTM
GUYHND
HTI
JAM
MEX
NIC
PAN
PER
PRY
SLV
TTO
URY
VEN
GBR
AUT
BELDNK
FRA
DEU
ITA
NED
SWE
FIN
GRE
IREPOR
SPA
El número de representantes por distritos en los sistemas bicamerales es el máximo entre las dos cámaras
Instituciones Electorales y Resultados Políticos
Representatives per district (log scale)
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
Rep
rese
nta
tio
n o
f th
e ex
ecu
tive
’s p
art
y i
n c
on
gre
ss
1 10 Effective number of parties
ARG
BHS
BRB
BLZ
BOLBRA
CHLCOL
CRI
ECU
SLV
GTMGUY
HTI
HND
JAM
MEX
NIC PAN
PRY
PER
DOM SUR
TTO
URY
VEN
Fragmentation and minority governmentsLower chamber
-0.12
-0.10
-0.08
-0.06
-0.04
-0.02
0.00
0.02
0.04
1 10 100 1000
ARGBHS
BLZ
BOL
BRA
BRB CHL
COLCRIDOM
ECU
GTM
HNDHTI
JAM
MEX
NIC
PAN
PER
PRY
SLV
TTO
URY
VEN
GBR
AUT
BEL
DNK
FRA
DEU
ITA
NED
SWE
FIN
IRE
PORSPA
Superávit Fiscal(% del PIB)
Representatives per district (log scale)
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1 10 100 1000
ARG
BHS
BLZ
BOL
BRA
CHLCOL
CRI
DOM
ECU
GTM
HND
JAM
MEX
PAN
PER
PRY
SLV
TTO
URY
VEN
GBR
AUT
BEL
DNK
FRA DEU
ITA
NED
SWE
FIN
GRE
IRE
POR
SPA
Public debtPercentage of revenues)
Representatives per district (log scale)
-0.60
-0.40
-0.20
0.00
0.20
0.40
0.60
0.80
1 10 100
ARGBOL
BRA
BRB
CHL
COL
CRI
DOMECU
GTM
HND
JAM
MEX
PANPERPRY
SLV
TTO
URY
VEN
GBRFRA
Pro-cyclicality of government consumptionvs. district magnitude
Representatives per district (log scale)
Budget institutions matter because they affect the rules of the game under which the different actors involved in the budget process interact, either by placing constraints to the whole process, or by distributing the power, information and responsibilities among the different agents, and thus affecting fiscal outcomes.
Following Alesina and Perotti (1995), we identify three different types of budgetary rules: numerical rules procedural rules rules that affect the transparency of the
budget
Balanced budget rules, such as those of the U.S. states
Maastricht criteria (which impose limits on deficit and debt)
Gramm-Rudmann-Hollings (in the US), which imposes a gradual reduction of deficits, until their elimination
Regarding the indicator of performance they refer to
regarding the legal rank of the norm that establishes them
regarding their coverage regarding the stage of the budget process in
which they apply regarding their “flexibility”
They may be non-contingent or contingent, with clearly specified escape clauses
may be defined on the basis of an indicator of structural deficits
as a general rule, the greater the flexibility, the greater the complexity, the easier it becomes to elude them
Pros: If they are enforced, they may solve the majority
of the problems identified above they limit the strategic used of debt they limit the transfer from future to present
generations they limit the electoral cycle they limit the common pool problem, etc.
Cons: They may generate incentives for “creative
accounting” They limit the possibility of engaging in tax-
smoothing (a la Barro) (at least in the case of balanced budget rules)
They tend to be too inflexible (in particular in the case of highly volatile regions such as Latin America)
Volatility itself may be induced by the absence of fiscal discipline. Thus, if the rule is effective, the need to respond to the cycle may decline
Even in the absence of numerical rules, Latin America has been characterized by having a procyclical fiscal policy.
It is possible to set the numerical rules so that they respond to the cycle (such as stabilization funds)
It must be simple, and easy to monitor has to be defined on the basis of fiscal indicators
which cannot be easily manipulated there must be a credible scorekeeper must be defined on the basis of fiscal indicators
which are to a reasonable extent under the control of the fiscal authorities
must be defined in such a way that the cost of complying with the rules should not be excessive under a reasonable set of likely circumstances
Gramm-Rudman-Hollings Maastricht The experience of the US states
Gradual reduction of the deficit to achieve balance
Limited results Strategic use of estimates Increase in creative accounting Part of the reduction was covered by
asset sales But GRH did have some effect on deficits
Criteria for access to common currency deficit/GDP<3% debt/GDP<60% Credibility of the rule is in this case
imposed by a group of countries (with some flexibility), not by the individual countries alone.
Have been effective in helping achieve convergence, but part of the adjustment was achieved through creative accounting, as well as a reduction in the quality of expenditures (Easterly 1998)
49 out of 50 states have balanced budget rules. The only exception is Vermont.
But they differ in several dimensions: legal rank of the rule (statutory or
constitutional) Coverage of the rule Stage of the budgetary process in which
they apply: drafting, approval or implementation.
States with more restrictive rules (see Poterba, 1995)... Tend to have lower deficits (Eichengreen 1992, Bohn and
Inman 1995) and lower debt (von Hagen 1991) tend to face lower interest rates, even after controlling
for the size of deficits (Goldstein and Woglom 1992, Eichengreen 1992, Lowry and Alt 1995, Poterba and Reuben, 1998)
adjust more in response to past deficits (Alt and Lowry 1994)
react by adjusting more during the fiscal year in response to adverse shocks (Poterba 1994)
have a less counter-cyclical fiscal policy (Bayoumi and Eichengreen 1996), but...
This is not translated into increased output volatility (Alesina and Bayoumi 1997)
They affect the rules of the game in the interaction among the different agents that participate in the budget process
May be more “hierarchical” or more “collegial”
Hierarchical rules concentrate the power on the finance minister vis a vis the spending ministers, and on the executive vis a vis the legislature
Collegial rules tend to allocate power more equally among all the actors involved
During the drafting of the budget: Hierarchical: At the beginning of the drafting of the
budget, spending ministers receive spending caps which they must observe.
Collegial: each spending minister drafts its own budget, and these are then negotiated within the cabinet.
During the approval of the budget: Hierarchical : Congress can modify the composition
of expenditures, but cannot increase total expenditure or deficits
Collegial: Congress may propose any changes, without restrictions
During the implementation of the budget: Hierarchical : The government may cut
expenditures unilaterally if revenues are lower than projected
Collegial: Congress has the initiative to propose increases in the budget, even after it has been approved
Pros: They may generate fiscal discipline by concentrating
power on those who are responsible for macro stability. May solve the common pool problem They are more flexible than numerical rules, and allow
a response to the cycle Cons:
They do not solve the electoral cycle problem They do not solve the problems associated to the short
time horizon of politicians. They do not solve the problem of the strategic use of
debt By allowing a greater degree of discretion, they may
have a slower effect on the credibility of fiscal policy
Budget Enforcement Act (US) The experience of the European Union The experience of Latin America
Studied by von Hagen (1992) and von Hagen and Harden (1995)
build index of BI based on relative power of finance minister within the cabinet structure of negotiations within the cabinet relative power of executive vis a vis legislative Degree of expenditure control by the finance
minister degree of transparency of the budget
They find that more hierarchical (centralized) institutions tend to reduce deficits and debt, without affecting the capacity of govt. to stabilize output.
Studied by Alesina, Hausmann, Hommes and Stein (1996) and by Stein Talvi and Grisanti (1998)
AHHS build an index of budgetary institutions, based on a questionnaire that was responded by budget directors in 20 Latin American countries, for the period 1990-1993
Includes the stages of drafting, approval, and implementation of the budget
1 Are there any constitutional or legal constraints on fiscal deficits?
2 Is there a requirement that the budget be consistent with fiscal targets previously specified in a macro program?
3 What kind of borrowing constraints are there on the government?
4 Is the authority of the Finance Minister greater than that of spending ministers on budgetary issues?
5 What kind of restrictions does Congress have to amend the budget proposed by the government?
6 What happens if Congress rejects the budget, or does not approve it within the constitutionally set time frame?
7 Can the budget be modified after approval? On whose initiative?
8 Can the government legally empowered to cut spending after the budget has been approved? Under what circumstances?
9 Does the government typically assume debt originally contracted by other public agencies? Under what circumstances?
10 Can subnational governments and public enterprises borrow autonomously?
We find that more hierarchical and restrictive budget institutions lead to smaller primary deficits
A difference of 20 points in the index (which ranges from 0 to 100) is associated with a difference of three percentage points of GDP in the primary deficit
This result is very robust to changes in the way the index is built, in changes in the methodology of estimation, as well as to the inclusion of other variables that control for the effects of: external shocks the economic cycle age structure of the population initial level of debt wars and natural disasters
0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8
DOMBOLSLVBRAHNDPERVENPRYECUCRI
ARGGTMBHSTTOURYPANMEXCHLJAMCOL
0.45
0.47
0.50
0.50
0.52
0.54
0.55
0.55
0.56
0.56
0.57
0.57
0.57
0.58
0.62
0.66
0.72
0.73
0.75
0.76
Index of budget institutions
-0.08
-0.06
-0.04
-0.02
0
0.02
0.04
0.4 0.45 0.5 0.55 0.6 0.65 0.7 0.75 0.8
ARGBHS
BOL
BRA
CHL
COLCRIDOM
ECU
GTM
HND
JAM
MEX
PAN
PER
PRY
SLV
TTO
URY
VEN
Index of budget institutions
Fiscal deficits:1990-95(% of GDP)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
0.4 0.45 0.5 0.55 0.6 0.65 0.7 0.75 0.8
ARG
BHS
BOL
BRA
CHLCOL
CRIDOM ECU
GTM
HND
JAM
MEX
PAN
PER
PRY
SLV
TTOURY
VEN
Index of budget institutions
Public debt: 1990-95(as a share of revenues)
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
0.4 0.45 0.5 0.55 0.6 0.65 0.7 0.75 0.8
ARGBOL
BRACHL
COL
CRI
DOM
ECU
GTM
HND
JAM
MEX
PAN
PER
PRY
SLV TTO
URY
VEN
La Prociclicalidad:1990-95(Correlación entre el Gasto Público y el PIB)
Index of budget institutions
…or limit electoral cycles
-0.04
-0.03
-0.02
-0.01
0
0.01
0.4 0.45 0.5 0.55 0.6 0.65 0.7 0.75 0.8
Los Ciclos Electorales:1990-95(Superávit Fiscal Promedio en años electorales menos Superávit Fiscal
Promedio en años pos-electorales)
Index of budget institutions
Off-budget items strategic use of macroeconomic forecasts
used for the drafting of the budget Treatment of contingent liabilities Creative accounting NEED FOR AN INDEPENDENT AND
CREDIBLE SCOREKEEPER WHY IS IT SUB-OPTIMAL TO LIE?
Numerical rules and procedural rules: alternative ways of introducing fiscal discipline But they solve different problems
Numerical rules and transparency: They are complements: without transparency,
numerical rules will not be effective However, the more restrictive the rule, the
larger the incentives for creative accounting Thus, if numerical rules are introduced, it is
important to improve transparency at the same time
Does not include numerical rules. It is based on procedural rules, and places a lot of emphasis on disclosure and transparency
Requires the government to follow a set of principles of responsible fiscal management
The government may depart from the principles, but must explain publicly why it does so, and indicate how and when it will conform with the principles again
Reduce debt to prudent levels, so as to provide a buffer against future adverse events, by achieving operating surpluses every year until prudent levels of debt have been achieved This suggests that debt reduction cannot be
achieved by selling assets Maintaining debt at prudent levels by
ensuring that, on average, over a reasonable period of time, total operating expenses do not exceed total operating revenues This allows for departures from budget balance
during recessions
Achieving levels of net worth that provide a buffer against future adverse events Recognizes that financial strength depends on
overall balance sheet, not just debt Managing fiscal risk prudently
Recognizes the need to treat contingent liabilities in a prudent way
Pursuing policies that are consistent with a reasonable degree of predictability about the level and stability of tax rates
Who defines what is a “prudent” level of debt, or a “reasonable” period of time over which the budget should be balanced?
The government of the time However, the government must justify
its interpretation of what is prudent and reasonable in parliament, as well as to the general public
A lot of emphasis on “disclosure” The government must present a Budget
Policy Statement well before the beginning of the budget year, which should include: their strategic priorities for the next budget their short-term fiscal intentions their long-term fiscal objectives
Three year horizon Regularly present updates of impact of
fiscal decisions.
0%
5%
10%
15%
20%
25%
Median Average
8.3%
15.6%
9.6%
17.2%
13.6%
19.3%
1985 1990 1995
Decentralization trends in Latin America
Su
bn
atio
nal
Exp
end
itu
re/T
ota
l exp
end
itu
re
services are better matched to preferences
greater accountability greater political participation innovations in services
Free riding Capture
Power to elect Power to spend Power to tax Power to borrow System of inter-governmental transfers
Success or failure depend on how these dimensions are organized and combined
Local Democracies
0
2
4
6
8
10
12
14
16
18
Co
un
trie
s
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97
Year
Number of countries where mayors are elected by the population
0% 10% 20% 30% 40% 50%
Subnational Expenditure/Total expenditure
ARG
BRA
COL
BOL
MEX
VEN
URY
CHL
HND
PER
GTM
ECU
TTO
PRY
SLV
NIC
PAN
DOM
CRI
BRB
BHS
Avg. OECD
Avg. LA
34.9%14.6%
Federal Unity
Decentralization in Latin America, 1995
Good local taxes are hard to findMobility of the tax base
Economies of scale
0% 20% 40% 60% 80% 100%
PERURYPRYBRACOLBOLHNDARGECUCHLMEXGTMVENSLVTTO
Average LAAverage OECD
5%
17%
23%
33%
38%
43%
49%
56%
58%
61%
61%
67%
83%
90%
92%
52%
42%
Vertical Fiscal Imbalance
Inter governmental transfers/ Total Subnational Collection
Discretional:Not stable or predictable
May generate soft budget constraints
Discretional:Not stable or predictable
May generate soft budget constraints
ARG
BOL
CHI
COL
ECU
SLV
MEX
PAN
PER
DOM
SUR TTO
VEN
Discrecionality in the transfer system
Mostly DiscretionalDistribution
HON, GUA, CRI
Mostly AutomaticDistribution
Mostly DiscretionalAmount
Mostly AutomaticAmount
DiscretionalNot stable or predictable
May generate soft budget constraints
Tied to revenue sources (most widely utilized)Prociclicality
Unwanted effects during adjustment
DiscretionalNot stable or predictable
May generate soft budget constraints
Tied to revenue sources (most widely utilized)
ProciclicalityUnwanted effects during adjustment
Earmarked (little utilized)Predictable and stable
They follow output not inputs
Varied experiences on the degree of borrowing autonomy
0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0
CHL
PAN
TTO
CRI
BOL
HND
VEN
DOM
GTM
URY
PRYSLV
PER
MEX
ECU
COL
BRA
ARG
0.5
0.5
0.5
0.5
1.0
1.0
1.0
1.0
1.0
1.0
1.5
1.5
1.8
2.0
2.0
2.9
3.0
Borrowing autonomy
Concurrent expenditure responsibilities High degree of vertical imbalance Discretionality in the transfer system Lax subnational borrowing rules that
may lead to possible bailouts
-0.12
-0.08
-0.04
0
0.04
0.08
0.12
Res
idua
ls*
0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45
Decentralization*Fiscal Imbalance*Borrowing Autonomy
BOL
BRA
CHL
COL
CRI
DOM
ECU
GTM
HND
MEX
PAN
PER
PRY
SLV
TTO
URY
VEN
Latin America
Note: Residuals for a total expenditure regression on the following control variablesInitial debt, population over 65 years, and degree of openness.
Strengthen local democracies Harden budget constraints
Limit vertical imbalance while maintaining efficiencyAdopt non-discretionary transfer rules
Clarify rules by avoiding concurrent responsibilitiesSet tight limits on borrowing autonomy of subnational
governments