Front Matter

Front Matter

Author(s):
Manmohan Kumar, and Teresa Ter-Minassian
Published Date:
October 2007
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    Promoting Fiscal Discipline

    Manmohan S. Kumar Teresa Ter-Minassian Editors

    INTERNATIONAL MONETARY FUND

    © 2007 International Monetary Fund

    Production: IMF Multimedia Services Division

    Cover art: Lael Henderson/Images.com/Corbis

    Cover design: Will Hoffman

    Figures: Bob Lunsford

    Typesetting: Alicia Etchebarne-Bourdin

    Cataloging-in-Publication Data

    Promoting fiscal discipline/Manmohan S. Kumar, Teresa Ter-Minassian, editors—

    [Washington, D.C.]: International Monetary Fund, 2007.

    • p. cm.

    Includes bibliographical references.

    ISBN 9781589066090

    1. Fiscal policy. 2. Finance, public. 3. Economic policy. I. Kumar, Manmohan S. II. Ter-Minassian, Teresa. III. International Monetary Fund.

    HJ192.5.P766 2007

    Price: $25.00

    Please send orders to:

    International Monetary Fund, Publication Services

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    Contents

    The following conventions are used in this publication:

    • In tables, a blank cell indicates “not applicable,” ellipsis points (. . .) indicate “not available,” and 0 or 0.0 indicates “zero” or “negligible” Minor discrepancies between sums of constituent figures and totals are due to rounding.

    • An en dash (–) between years or months (for example, 2005–06 or January-June) indicates the years or months covered, including the beginning and ending years or months; a slash or virgule (/) between years or months (for example, 2005/06) indicates a fiscal or financial year, as does the abbreviation FY (for example, FY2006).

    • “Billion” means a thousand million; “trillion” means a thousand billion.

    • “Basis points” refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point).

    As used in this publication, the term “country” does not in all cases refer to a territorial entity that is a state as understood by international law and practice. As used here, the term also covers some territorial entities that are not states but for which statistical data are maintained on a separate and independent basis.

    Preface

    In recent years, there has been a growing recognition of the budgetary challenges looming ahead for many industrial, emerging market, and developing economies. These arise from a variety of sources: for instance, demographic developments entailing the aging of populations will have profound implications for pensions and health care spending as well as economic growth; the ongoing process of globalization—while bringing significant benefits—can create potentially large uncertainties for public revenues by affecting the taxing power of national governments; and global climate change is likely to adversely affect economic performance and the public finances of many countries. These challenges require the pursuit of prudent fiscal policies to create budgetary resources to respond to them. Prudent policies are also an important prerequisite for macroeconomic as well as financial stability, and for providing flexibility to respond to adverse shocks. Moreover, the need for fiscal discipline is underlined by the increasing role played by financial markets, and by the open capital accounts since benefits from a free flow of capital are contingent on sound policies.

    There is no doubt that the budgetary positions of many industrial and emerging market countries have improved over the past two—three years: many countries have taken steps to strengthen their underlying fiscal positions, but, more important, stronger economic activity has boosted tax revenues and reduced spending on unemployment benefits. Despite this improvement, long-term fiscal sustainability has yet to be secured in many countries. Moreover, it will remain elusive if an expectation of continued benign economic conditions leads to complacency. The current good times should be used to provide an opportunity to direct the focus of fiscal policy to the challenges that lie ahead, but it is precisely during good times that there is generally the most resistance to further implementing measures to put public finances on a sustainable footing for the long term.

    There are a variety of political economy and institutional factors that can give rise to fiscal indiscipline, and this book explores measures that can help deal with them. Fiscal indiscipline manifests itself in a number of different ways: it is reflected in unrealistic macroeconomic assumptions, most commonly for economic growth, that underlie budgetary policy. The unduly optimistic projections regarding revenues that this gives rise to are often used to respond to unrealistic political demands on the budget. The difficulties in maintaining fiscal discipline arise in part because of inadequate transparency, but the main underlying cause stems from the injudicious use of discretion. In particular, in the context of competing electoral constituencies and political and distributive conflicts, the availability and exercise of discretion, interacting with budgetary institutions, leads to the use of available resources without regard to the overall budgetary situation. The result is a tendency to spend revenue windfalls and incur excessive deficits. Such fiscal expansion in good times leads to procyclicality in the short run. But, in addition, given that the windfalls are not used to improve the underlying position, and that the fiscal position worsens during bad times, such policy often leads to a rising trend in public debt in the long run. The adverse effects of injudicious discretionary spending are particularly notable during economic upturns when there are revenue windfalls and access to market finance is plentiful.

    This book addresses some of the key issues involved in promoting fiscal discipline, with a particular emphasis on output stabilization and the cyclicality of fiscal policy, and on ways to avoid procyclicality in good times. It examines the role and determinants of fiscal discipline, the extent, consequences, and causes of procyclicality, and “mechanisms” that could help reduce procyclicality and strengthen fiscal discipline—targeting cyclically adjusted fiscal balances, the introduction of fiscal responsibility laws, and the creation of nonpartisan fiscal agencies.

    The chapters in this book have benefited significantly from the advice and expertise of many of our colleagues in the Fiscal Affairs Department. We are particularly grateful to Richard Hemming for his comments and suggestions on earlier drafts of the chapters. In addition, helpful comments were received from Mark De Broeck, Dennis Botman, Jiri Jonas, and Graciela Kaminsky. Giovanni Ganelli and Emanuele Baldacci provided valuable inputs to the earlier versions of Chapters 3 and 5, respectively. We are also grateful to Annette Kyobe and Jamal Ismayilov for excellent research assistance, and Veronique Catany, Claudia Nobre, and Laura Cabello for secretarial and administrative assistance. Esha Ray of the External Relations Department ably edited the manuscript and coordinated production. Views and errors are entirely the responsibility of the authors, and should not be attributed to the International Monetary Fund, its Executive Board, or its management.

    Manmohan S. Kumar

    Teresa Ter-Minassian

    Abbreviations

    BSL

    Budgetary Stability Law

    CAB

    Cyclically adjusted fiscal balance

    CBO

    Congressional Budget Office

    CPB

    Central Planning Bureau

    EMU

    Economic and Monetary Union

    EU

    European Union

    FC

    Fiscal council

    FMRA

    Fiscal Management Responsibility Act

    FPB

    Federal Planning Bureau

    FRA

    Fiscal Responsibility Act

    FRBMA

    Fiscal Responsibility and Budget Management Act

    FRDD

    Fiscal Responsibility and Debt Delimitation Act

    FRL

    Fiscal responsibility law

    GAAP

    Generally Accepted Accounting Practice

    GDP

    Gross domestic product

    IFA

    Independent fiscal authority

    IFI

    International financial institution

    IMF

    International Monetary Fund

    NFPS

    Nonfinancial public sector

    OECD

    Organization for Economic Cooperation and Development

    PAYGO

    Pay-as-you-go

    PFM

    Public financial management

    SGP

    Stability and Growth Pact

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