Since the early 1970s, fiscal deficits and rising public debt have been ubiquitous features of government budgetary positions. Indeed, in aggregate, fiscal balances of both industrial and developing economies have been negative in each of the past 30 years, with an average deficit of about 3 percent of GDP a year for both groups (Figure 1.1). In recent years, an improvement in the overall fiscal positions in the industrial economies during the economic and financial market boom in the 1990s was quickly reversed thereafter. In many developing economies, although there has been a welcome turnaround in budgetary positions over the last 4 years, this reflects in large part cyclical factors, higher commodity prices, and a benign global financial market environment. 1
Mr. Xavier Debrun, Mr. David Hauner, and Manmohan S. Kumar
Economic analysis has long recognized that policymakers, particularly in the fiscal domain, act quite rationally according to specific incentives, including reelection concerns, pressures from interest groups and constituencies, and the need to honor specific pledges or commitments. Growing evidence of fiscal indiscipline and procyclicality has prompted a debate on the likely distortions causing and arising from such behavior, and on effective ways to correct policymakers’ incentives in a socially beneficial way. This chapter examines how distorted incentives may undermine a judicious use of fiscal discretion, and explores how fiscal frameworks could improve fiscal behavior and outcomes.
Although some debate on the feasibility and effectiveness of fiscal policy in stabilizing output fluctuations continues, there is little disagreement that, as a rule, policy should not be procyclical. The standard Keynesian approach suggests that fiscal policy should act in a stabilizing manner, while within the neoclassical paradigm, tax-smoothing models imply that fiscal policy should remain neutral over the business cycle. Even in a Ricardian framework, where a reduction in taxes or an increase in spending leads to an equivalent rise in private sector saving, policy would not be expected to be procyclical.
The search for more comprehensive institutional arrangements to improve fiscal policy outcomes intensified during the last decade. Analogous to the monetary policy debate, while discussions initially centered on the general issue of rules versus discretion, more recently they have turned into a search for broader institutional arrangements that would help ensure the desired fiscal policy outcomes. Recognizing the limited scope for improvement that stand-alone fiscal rules can provide, and the frequent lack of immediate results from enhanced transparency alone, fiscal responsibility laws (FRLs) have been enacted in many countries as permanent institutional devices aiming to promote fiscal discipline in a credible, predictable, and transparent manner. New Zealand was at the forefront of these reforms, adopting an FRL in 1994. More recently, FRLs have been implemented in several countries in Latin America, Europe, and Asia.
This paper provides a number of complementary estimates of potential output and the output gap—variables that cannot be observed directly. After a substantial increase in the tax wedge in the 1970s and the 1980s, which has been widely thought to have been partly responsible for the sharp rise in unemployment rates, the Belgian authorities instituted a policy of reduction in employers' social security contributions. The reforms will reverse the increase in average income tax rates during the 1990s.
The European Union’s (EU) financial stability framework is being markedly strengthened. This is taking place on the heels of a severe financial crisis owing to weaknesses in the banking system interrelated with sovereign difficulties in the euro area periphery. Important progress has been made in designing an institutional framework to secure microeconomic and macroprudential supervision at the EU level, but this new set-up faces a number of challenges. Developments regarding the financial stability may assist in the continuing evolution of the European financial stability architecture.
This 2015 Article IV Consultation highlights that Belgian economy has shown considerable resilience but the outlook is weighed down by weak demand in Europe. Healthy private balance sheets, integration with Germany, and employment support schemes have helped sustain employment and economic activity. However, output is still well below potential and with, subdued growth prospects, job creation remains insufficient. Fiscal adjustment is expected to resume after a pause in 2014. The pace of adjustment targeted by the authorities for 2015–16 is appropriate given the level of debt and related risks.
This Selected Issues paper focuses on the fiscal challenge for Belgium in coping with population aging, including the sustainability of prevailing fiscal federalism arrangements across all levels of governments. The analysis demonstrates that the current strategy of upfront consolidation is likely to fall short of achieving sustainability. Further reductions in aging-related spending and growth and productivity-enhancing reforms beyond those assumed under the authorities’ strategy appear to be necessary. The paper also assesses whether the wage bargaining framework, a key labor market institution, is conducive to preserving external competitiveness and raising employment rates.