The structure of the presentation reflects an approach in which the fiscal rule is perceived as a valuable practice placed within a broader institutional framework designed to favor fiscal sustainability.
More generally, the macroeconomic framework for our small, open economy involves an autonomous central bank that follows an inflation target, with a flexible exchange rate regime, and in which financing to the government is prohibited. Fiscal policy observes a fiscal rule based on the structural balance,1 which is acyclical.
Meanwhile, fiscal institutionality seeks to align incentives with checks and balances, for which the proper distribution of roles between the Executive and Congress is essential. Thus, the Executive, being in charge of fiscal policy and public finances, has the exclusive initiative in matters of financial administration of the State. This includes proposing tax amendments, expenditure, and institutional changes to the Congress, and must observe the principle that revenue should not be earmarked. It also involves broad flexibility for budget management, which is subject to centralized administration. By contrast, Congress must approve public expenditure (it may reduce, but not increase or reallocate expenditure). In addition, when financing through an increase in gross debt exceeds the presidential term, a qualified quorum is required for approval, giving Congress a stronger hand in this decision. In other words, the design limits financial commitments that go beyond the presidential term, by subjecting gross debt to approval requirements. This rule was designed when the government had no substantial financial assets to finance expenditure and the only option was increasing debt. Today´s asset availability might invite us to explore setting a limit to net debts.
There are a number of other important institutional rules, and our purpose here is not to exhaust their analysis. Some were only mentioned in the presentation, while other requirements, such as lengthy experience with fiscal rules2 and a high collective opinion of macroeconomic equilibria and fiscal responsibility, are cultural.
Moving to the more specific analysis of the fiscal rule, which is designed to guide public expenditure in an isolated long-term economic trend, the exercise is based on the estimation of two central parameters: cyclical economic growth and long term copper prices, both unobservable variables. This information is used to establish a trajectory for expenditure, for a given level of structural revenue—given a reference level for the structural balance goal. The level of the goal must be defined by taking account of liabilities, including contingent liabilities, among other factors, so as to ensure convergence with a sustainable level of debt.
One important point is that the structural parameters and the design model for the rule do not isolate the cycle completely, and that structural revenue is more volatile than would be desirable. Moreover, the methodology is highly complex, which reduces reliability and control, while it provides room for potential errors that are difficult to detect in time, and undermines credibility. All of these factors are difficult to compensate for through transparency alone. Efforts are therefore required in the pursuit of simplicity, by giving consideration to the elimination of those adjustments to effective revenues that might be contributing relatively more to the complexity of the rule than to the cyclical adjustment.
In light of the complexity of the rule, and the recent experience with periods of frequent change, the recent approval of the law creating the Autonomous Fiscal Council is a step forward in terms of ensuring transparency, control, and monitoring in this connection, thereby significantly reducing the impact of these problems.
However, we shall mention a number of complementary tools that would enable the Autonomous Fiscal Council to play an active complementary role. In fact, although the fiscal rule provides an annual target that is compatible with a sustainable trajectory, it is based on unobserved variables and does not include increases in contingent liabilities or future expenditure commitments. While changes in contingent liabilities can be expected to modify the optimal level of the structural balance, optimal corrective mechanisms do not exist. Similarly, future expenditure commitments are not necessarily incorporated as contingent liabilities and certainly not within long-term projections.
It would therefore help to improve the methodology for medium-term revenue and expenditure projections, including budget leeway; to prepare long-term revenue and expenditure projections; to perfect and generate methodologies for committed public expenditure and flexible expenditure; and to refine contingent debt estimates. The medium and long-term projections must also be kept up to date, establishing the requirement that financial reporting under draft laws having a significant medium-term impact must show its impact in the projections (in accordance with the same reasoning as the approval of gross debt extending beyond the presidential term).
Moreover, a number of areas were mentioned that may be worthy of consideration as mechanisms to enhance the mobility of less efficient public programs or to assess the impact of the fiscal rule on public enterprises.
In addition, it is worth stressing that it is more difficult to adjust costs down than up. To the extent that the share of variable expenditure is smaller, the cost of reducing public spending is higher. For this reason, an acyclical rule is more appropriate than a countercyclical one. In other words, it is advisable to limit countercyclical policies to automatic reversal measures such as advance refunds, and avoiding others like unemployment programs which had demonstrated that they tend to become permanent. In fact, as a result of the current volatility of structural revenue and the problems in connection with structural parameters, it is advisable to strengthen the fiscal rule with the establishment of a maximum deficit. However, some exceptional situations require more fiscal stimulus than the rule provides, as well as more substantial effective deficits. In really exceptional cases, departures from the rule should be subject to certain costs and protocols to formalize the exceptional nature of the situation as well as to strengthen the ex-post convergence path.
