Toward a Comprehensive Rules-Based Macro-Fiscal Framework

Friday, February 23

Mr. George Kopits, Member of the Portuguese Public Finance Council, and Senior Scholar at the Woodrow Wilson Center


How can fiscal authorities commit to pursue a predictable and transparent fiscal policy? What is the role of fiscal rules, transparency standards, and independent fiscal councils? On February 23, 2018, George Kopits, Member of the Portuguese Public Finance Council and Global Fellow at the Woodrow Wilson International Center for Scholars, presented his views on these questions at a public JVI lecture. The event, chaired by JVI Director Thomas Richardson, was attended by participants in the courses on Sound Fiscal Institutions and Macroeconomic Management in Resource-Rich Countries and by numerous guests from the Vienna community.

Why a rules-based framework?
Mr. Kopits began by listing the various failures related to discretionary fiscal policy, such as time inconsistency, the common-pool problem, and deficit bias, and by describing their contribution to macroeconomic instability, fiscal sustainability problems, erosion of policy credibility, unanchored expectations, and in some cases, to financial crisis. A rules-based macrofiscal framework can help overcome these problems by demonstrating that the fiscal authorities are committed to pursuing a predictable and transparent fiscal policy over time. Though that commitment does not eliminate discretion, it does limit it, while still allowing enough flexibility to respond effectively to economic shocks and cycles.

The three components of a well-functioning rules-based framework are (a) policy and procedural rules, (b) transparency standards, and (c) monitoring of compliance, generally by an independent fiscal institution. Adhering to such a framework can to a large extent depoliticize fiscal policy and anchor the expectations of economic agents and financial markets, which reduces uncertainty and extends the time horizon of investment and saving decisions.

The role of fiscal rules
Mr. Kopits then moved on to discuss policy rules, which he defined as permanent constraints on fiscal policy; these are typically expressed in terms of a summary indicator of fiscal performance, often specified as a numerical target or ceiling. The three types of fiscal rules that he explored were budget balance, debt, and expenditure rules, identifying for each the main features, such as the statutory basis, coverage, implementation, and sanctions for noncompliance. He also commented on the usefulness of procedural rules, especially medium-term budgetary planning.

Transparency and independent fiscal institutions
Simply setting fiscal rules does not ensure a sound fiscal framework, Mr. Kopits said; there also has to be a way to monitor compliance with the rules. This can be done by making fiscal policy more transparent and by establishing an independent “watchdog” institution. He then discussed standards set out in the IMF Code of Fiscal Transparency, such as timely availability of information, broad institutional coverage, reliable public sector accounts, unbiased macrofiscal forecasts, and proper assessment of fiscal risks.

Independent fiscal institutions, either under individual leadership or in the form of a  council, are charged with real-time surveillance of fiscal policymaking and compliance with fiscal rules. They also forecast both short- and medium-term effects of fiscal measures and assess long-term fiscal sustainability. The role of a council is to help prevent opacity in public finances and minimize government attempts to evade fiscal rules through the use of over-optimistic forecasts, creative accounting, off-budget operations, or excessive contingent liabilities. These institutions should not have a policymaking role, and any potential advisory role should be very limited.

International experience
Mr. Kopits closed by briefly reviewing international experience with fiscal rules and fiscal councils. The evidence accumulated so far suggests that, on balance, the experience has been favorable: Countries with fiscal rules that were well-applied as well as countries with well-functioning fiscal councils suffered less from creative accounting and manipulation of fiscal data and benefited from enhanced policy credibility, a decline in the risk premium, more sustainable public debt, and above-average economic growth and stability. They also managed to create fiscal space and conduct countercyclical expansionary fiscal policy. Although these observations proved true for both advanced and emerging market economies, to some extent they should be regarded as preliminary because to prove itself each new framework has to operate through at least two full economic and electoral cycles. He pointed out the spectrum of experiences, from full success in Chile and Sweden to somewhat mixed results in Brazil and Peru, and to only short-lived success in Venezuela and Hungary.

His talk was followed by a lively discussion with the audience on the role of fiscal rules and fiscal councils in countries in Southeast Europe, the Caucasus, and Central Asia, where credibility and trust in policymaking still needs to be built. The conversation also touched on the issue of gender balance in the governing bodies of fiscal councils and the complexity of the present EU fiscal framework.

Adam Gersl, Senior Economist, JVI

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