Fiscal Adjustment for Stability and Growth

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Back Matter

James Daniel
Published Date:
August 2006
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    This broader definition of fiscal adjustment (compared with common usage equating fiscal adjustment with consolidation) reflects the increased emphasis on situations that warrant fiscal expansion.

    Only a few references are included in the main text. The bibliography section provides a fuller listing.

    If, however, the government “represses” financial markets by controlling domestic interestrates, more government borrowing will result in either higher inflation and low (evennegative) real interest rates or reduced financial intermediation—a reduction in the share of savings channeled through formal financial institutions to private investors. The quality of private investment suffers too: with credit rationed, governments typically end up choosing who gets credit and choosing less well than the market would.

    Excess economic volatility can also cause irreversible losses in human capital—including through the effect of more frequent spells of unemployment on learning-by-doing opportunities—compounding the negative effect on growth (Martin and Rogers, 1997).

    The initial stages of trade liberalization—which typically involve replacing nontariff barriers, such as quotas, with tariffs—tend not to be associated with revenue loss (IMF, 2005a). But many low-income countries seem to have had difficulty in replacing any revenue loss resulting from trade reform. Those that succeeded (1) sustained efforts, over several years, to broaden tax bases, including by improving revenue administration; (2) strengthened the domestic consumption tax system, through excise taxes and especially by a simple, broadbased, VAT; and (3) increased income taxes.

    See Heller (2003) for a fuller discussion of long-term fiscal challenges.

    More formally: CA=(SprivIpriv)+(SpubIpub), where CA is the external current account balan ce; Spriv, private sector savings; Ipriv, private sector investment; Spub, public sector savings;and Ipub, public sector investment. Spub - Ipub is a measure of the overall fiscal balance. The precise definition of each sector is critical (see Section III, What Makes Fiscal Adjustment Successful?).

    The real exchange rate is the relative price of tradables (such as televisions) to nontradables (e.g., haircuts). A real exchange rate depreciation (appreciation) improves (worsens) the external current account by diverting resources from the nontradable (tradable) to the tradable (nontradable) sector.

    Public sector wage increases could increase private sector wages by, for example, forming a benchmark for private sector wage increases or by raising the wage the private sector would need to offer to be competitive.

    The Government Finance Statistics Manual 2001 is a reference volume for government finance statistics. It covers concepts, definitions, classifications, and accounting rules, and provides a comprehensive analytic framework within which to summarize and present fiscal data in a form appropriate for analysis, planning, and policy design.

    In IMF publications, social security funds are normally classified with the level of government at which they operate. If the social security system is autonomous, with its liabilities perfectly matched with its assets (a defined contribution, or fully funded, scheme), it would be treated as part of the nonfinancial public sector.

    The exact linkages are complex and depend on the specific accounting definitions. For example, including lending minus repayments “above the line” (unlike in GFSM 2001; see Box 2) would imply that the overall balance would not equal the change in the government’s net financial position.

    While the terms cyclically adjusted and structural balances are often used interchangeably, structural balances refer to fiscal balances adjusted for deviations from benchmark levels of all economic variables with a significant fiscal impact (not just output).

    These include taking into account changes in the composition of output when estimating the output gap, as well as relying on estimates of built-in elasticities, excluding the impact of discretionary measures.

    The composition of liabilities can also be an important source of vulnerability (see Section I, Fiscal Adjustment to Reduce Vulnerability).

    In algebraic terms: Δb=d+(rg)b,whereb is the ratio of government debt to GDP (with Δ indicating the change in the ratio from one year to the next); d, the primary deficit ratio to GDP; r, the real interest rate; and g, the growth rate of real GDP.

    More sophisticated versions of the formula differentiate between domestic currency debt and foreign currency debt, while also taking into account non-debt-creating deficit financing (e.g., privatization receipts) and debt-creating items (such as the recognition of contingent liabilities), which are not captured in the deficit.

    Absorptive capacity typically refers to limits on a country’s ability to use aid effectivelyowing to the quality of a country’s policies and institutions and lack of administrative capacity in the form of specific skills or, more generally, of insufficient human resources and physical conditions (infrastructure and equipment) for policy and program implementation.

    Absorption in this context measures the extent to which aid engenders a real resourcetransfer through higher imports or through a reduction in domestic resources devoted to producing exports. If the incremental aid directly finances imports, or is in-kind aid, spending and absorption are equivalent.

    Independent fiscal authorities are an alternative to numerical rules to depoliticize fiscal policy decisions, but devolving such authority can be politically difficult. Fiscal councils that provide independent analysis are a less politically difficult option, but they are less binding on policy.

    Procedural rules aim to enhance transparency, accountability, and fiscal management. They typically require the government to commit up-front to a monitorable fiscal policy strategy, usually for a multiyear period, and to routinely report and publish fiscal outcomes and strategy changes.

    Under both “zero-rating” and “exemption,” no tax is charged on sales; they differ, however, in that taxes paid on inputs are refunded under zero-rating but not under exemption.

    A tax, duty, or fee that varies based on the value of the products, services, or property on which it is levied.

    A schedular tax system disaggregates income into components such as labor income, dividends, and royalties and then separately applies tax rates and exemptions.

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