Fiscal Responsibility Laws

Several countries have adopted fiscal responsibility laws specifying budgetary procedures and rules to strengthen fiscal policy transparency, accountability, and stability. Fiscal responsibility laws establish requirements that the executive transparently state its short- and medium-term policy objectives, set short- and medium-term targets for fiscal flow and stocks, provide transparent information on budget planning and execution to the legislature, implement a fiscal policy conducive to fiscal stability and solvency, and account ex post for its fiscal policy execution and attainment of policy objectives (Lienert, 2010).

However, fiscal responsibility laws do not necessarily spell out an explicit fiscal rule. Conversely, fiscal rules are often adopted in the absence (or outside) of a fiscal responsibility law. For example, in 2008, Germany adopted a fiscal rule by constitutional amendment, not as part of a fiscal responsibility law.

Fiscal responsibility laws are often enacted as a legal tool in support of the consolidation of fiscal adjustment, which sometimes occurs under a stabilization program agreed with the IMF so that its emphasis is on budgetary control rather than effective fiscal policy. However, in other conditions, such laws are adopted with the aim of strengthening the institutional framework for fiscal policy, focusing on the above-mentioned components of a modern institutional framework, such as in Chile’s case.

A selective review of fiscal responsibility laws adopted by 13 developed and developing countries since 1998 shows that these laws specify an explicit fiscal rule in 9 countries, define escape clauses in 7 countries, and set penalties for overspending in 6 countries (IMF, 2009). The evidence on the success of fiscal responsibility laws is mixed. When the targets are realistic and there is political will for taking necessary corrective measures to achieve them, these laws have been successful (e.g., in Australia and New Zealand). However, in many emerging economies, they have been unsuccessful in meeting their quantitative targets (e.g., in Argentina, Colombia, Peru). Cáceres, Corbacho, and Medina (2010) find limited empirical evidence in support of the view that fiscal responsibility laws have had a significant effect on fiscal performance.

Chile enacted Law No. 20128 on Fiscal Responsibility in 2006 to strengthen the institutional framework for a fiscal rule adopted five years earlier by a previous administration. This law was not adopted to enforce fiscal adjustment but to develop the institutional framework required to strengthen the links between the fiscal rule, the use of government savings, and the establishment of two SWFs. Its major provisions are the following (Rodríguez, Tokman, and Vega, 2006):

Note that that this law does not impose a particular fiscal rule on the government. It rather imposes a requirement to adopt and implement a fiscal policy aiming at fiscal sustainability and a distinction between actual and cyclically adjusted balances. This provides sufficient flexibility to new governments to define the explicit formula for the fiscal rule they commit to at the start of their administration. In addition, the law defines new institutions—adopted in 2006 and 2007—that strengthen operation of the fiscal rule.

Financial Management of the Budget

International best practice in regard to budgetary management is based on the adoption by the MoF of the following core elements for an efficient financial management (Ter-Minassian, 2010):

International evidence shows that countries that meet these requirements achieve better performance in budget execution, stability, and sustainability of fiscal policy (Alesina and Perotti, 1996; Stein, Talvi, and Grisanti, 1998; Alesina and others, 1999; Ter-Minassian, 2010).

Chile’s strong presidential system empowers the government with budgetary initiative (not shared with congress) and strong control over budget design and negotiation of the budget with congress. The executive holds the sole power of tax initiative. Congress lacks line-item veto and is entitled only to vote for or against the government’s proposed budget bill. Congress also lacks in-house capabilities to assess and evaluate in depth current fiscal policy, projections in the budget bill, and underlying macroeconomic assumptions.

However, significant budget negotiations take place between the government, represented by the MoF, and congress before the budget comes to vote. The latter negotiations tend to focus on budget composition (i.e., spending) rather than on taxation or the overall resource constraint, not the least because of the constraints imposed by the fiscal rule on the budget’s overall resource envelope.

Budget-Planning Horizon

Many countries are reforming their budget planning, shifting from a one-year horizon to a multiyear horizon. This change is aimed at different objectives: (1) achieving greater transparency, consistency, and intertemporal sustainability of fiscal policy; (2) reducing government short-term bias in public spending decisions; and (3) committing to a path of gradual correction of initially unsustainable fiscal positions.

On the one hand, there are governments that lack fiscal rules but adopt multi-annual budgeting to enhance sustainability and credibility of fiscal policy. On the other hand, there are governments that have one-year budgeting but that have adopted fiscal rules based on cyclical adjustments. The latter governments have an implicit multiannual budget horizon by distinguishing between actual and cyclically adjusted government accounts and balances. However, in the latter cases, the dissemination of explicit multiyear budgetary and fiscal targets contributes to additional potential gains in fiscal policy sustainability and credibility as well as macroeconomic stability.

Chile has a one-year budgeting framework in place. However, the aforementioned 2006 Fiscal Responsibility Law includes two items that require governments to adopt a fiscal policy that is at least in principle consistent with a horizon that exceeds one year: (1) the requirement imposed on new administrations to present their four-year fiscal policy framework and its implications for the cyclically adjusted government balance and (2) the requirement that the MoF submit annually, together with the draft budget law, a medium-term budget projection.

Moreover, by adhering to a CAB rule, governments are required to base the next year’s budget proposal on medium-term projections for GDP and the price of copper.

Chile’s government is not required to produce or commission long-term projections for government accounts and budgets based on the systematic assessment of fiscal sustainability and regular evaluation of long-term consequences of fiscal decisions with budgetary implications, like those conducted by the U.S. Congressional Budget Office and other governments in the world. However, there has been one exception to this rule, which was the commission of a technical study, required by the 2006 law, to assess the funding needs of the PRF to meet the government liabilities derived from the government pension subsidy (Pilar Pensional Solidario).

Fiscal Rules

The number of countries with fiscal rules at the national level has grown steadily over the past two decades, from 10 countries in 1990 to 30 in 2001 (which is also the year that Chile adopted the fiscal rule) and 51 in 2009 (IMF, 2009). Countries with fiscal rules adopted on average 2.5 active fiscal rules in 2009.

Fiscal rules are adopted to attain one or more of three objectives—sustainability of public debt, control of government size, and contribution to cyclical stability. Rules differ widely across countries in how they are defined. One category of rules comprises those that define numerical targets (targets, ceilings, or floors) for government balances, overall revenues, or expenditures that are fixed and hence independent of the business cycle. A paramount example of the latter rules is the Stability and Growth Pact ceilings on government deficit (3 percent of GDP) and debt (60 percent of GDP) for European Union (EU) member countries that were systematically violated before 2008 and have been almost universally thereafter. A second category is the fiscal rules that focus on stabilizing CABs, allowing for cyclical changes in actual government balances, with the aim of implementing a countercyclical fiscal policy or at least avoiding a procyclical policy bias. According to the IMF (2009), 10 countries (including Chile) had such a rule in place in 2009. Among them, only Germany, Sweden, and the United Kingdom had a fiscal rule in place that defines a numerical target for the actual budget balance throughout the economic cycle.

The IMF (2009) reviews the relative advantages of different fiscal rules, their design and complementarity with other institutional changes, the institutional prerequisites and economic determinants, and the strength in design, execution, and correction of deviations. It also positively assesses the fiscal and macroeconomic effects of fiscal rules in the world.

As noted previously, Chile is among the 10 countries with a fiscal rule that aims at stabilizing government CABs. However, in contrast to the other 9 cases, Chile corrects not only for the cyclical influence of the business cycle, as reflected by GDP deviations from trend, but also for the cyclical deviations of the price of copper from trend. Therefore, Chile’s experience is unique in the world and is exemplary for commodity-exporting countries, as highlighted by the IMF (2009).

However, unlike other countries with fiscal rules in place, Chile has established neither ex ante escape clauses from the rule that would apply under prespecified conditions nor ex post sanctions for violating the rule and ex post regulations to correct deviations from the rule.

Rules for Management of Government Assets and Liabilities

As commodity-exporting countries benefited from significant fiscal surpluses during the extended boom in commodity prices over the last decade, many of them have started to save their surpluses in SWFs invested in internationally diversified portfolios. This has been observed in countries with and without fiscal rules. Up to late 2009, 37 countries had SWFs in place, with outstanding aggregate assets of US$3.8 trillion. In the case of Chile, the outstanding investments of its two SWFs added up to US$14.7 billion at the end of 2009.

Countries with SWFs have committed to rules for saving in and dissaving from their funds. In the case of countries with a fiscal rule in place, accumulation into and withdrawal from their funds is determined by the rule. In addition, many countries have adopted legislation and institutions that define investment policies and management principles of their funds.

As mentioned above, in the case of Chile, its two SWFs were established by the 2006 Fiscal Responsibility Law. The latter also established the Financial Advisory Committee on Sovereign Funds of the Ministry of Finance, which advises the MoF on investment policies of these funds.

However, Chile (like most countries in the world) lacks both a policy and an institution focused on consistent management of government financial assets and liabilities with explicit objectives including risk, return, liquidity, and benchmarking.

Moreover, there is no comprehensive management of the government’s total balance sheet, including financial and nonfinancial assets, as well as explicit and contingent financial liabilities.

Requirements in Regard to Budget Accountability and Provision of Information on Financial Management

Worldwide efforts are underway by governments to improve accountability of their fiscal policy and transparency in the provision of financial information. This trend responds to the growing political and academic consensus about the democratic and economic efficiency gains of fuller accountability and transparency in fiscal policy. Although there is little empirical evidence on the benefits of high levels of accountability and transparency in fiscal policy, it seems legitimate to qualitatively infer from the evidence of accountability and transparency benefits associated with monetary policy (e.g., Geraats, Eijffinnger, and van der Cruijsen, 2006; Geraats, 2008).

The International Budget Partnership (2010) has compiled an Open Budget Survey, which is an international comparative database on partial and aggregate measures of global transparency and accountability of the budgets of central governments in the world. In the 2010 version of the survey, Chile ranked eighth among 94 countries (Figure 7.1 depicts ranking results for a selected subsample).

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Government Budget Transparency and Accountability, 2010

Source: International Budget Partnership (2010).

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Transparency in regard to the two key budget assumptions—future GDP growth and copper prices—was ensured almost from the start of Chile’s fiscal rule, as projections for the two variables made by two ad hoc committees were made public (this is discussed in more detail later in the chapter). However, mapping of the latter projections into the actual budget calculations could not easily be replicated, particularly after several changes to the rule were introduced in 2008 and 2009. However, the 2010 Report on Public Finances for the Budget Law 2011 made significant improvements in the provision of information on the calculation of the CAB, which was coherent with the recommendations provided by the Advisory Committee on Fiscal Policy (2010, 2011).

Regarding SWFs, international heterogeneity in their management and investment accountability and transparency is very great. In the most recent international ranking of transparency in the management of SWFs, published by the Sovereign Wealth Fund Institute (2011), Chile ranked first, together with SWFs of seven other countries, including Norway’s Pension Fund (Figure 7.2). In general terms, the current state of transparency and accountability of Chile’s government accounts is varied, ranging from moderate to high.

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Transparency of Sovereign Wealth Funds, 2011

Source: Sovereign Wealth Fund Institute (2011).Note: 1MDB: 1 Malaysia Development Berhad; ADIA: Abu Dhabi Investment Authority; CAD: China-Africa Development; CIC: China Investment Corporation; EIA: Emirates Investment Authority; GIC: Government of Singapore Investment Corporation; IPIC: International Petroleum Investment Company; NSSF: National Social Security Fund; PIF: Public Investment Fund; SAFE: State Administration of Foreign Exchange; SAMA: Saudi Arabian Monetary Agency; UAE: United Arab Emirates; US: United States.

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External Control and Auditing

There are three levels of external control and auditing of government budgets and accounts—the legislature, the government’s general comptroller or auditor, and fiscal councils and committees. In most countries, congress and especially the general comptroller exercise traditional accounting, financial, and managerial control of budget execution and government accounts. More recently, countries have been adopting fiscal committees and councils, which are empowered to provide an economic assessment of fiscal policy design and execution.

In Chile, government accountability in regard to budgetary compliance is largely limited to oversight and control by the General Comptroller’s Office (Contraloría General de la República). This institution focuses on accounting, procedural, and legal compliance by the government in its implementation of fiscal policy and execution of the budget. This oversight and control function by the General Comptroller is exercised at all levels of government. In this way, the General Comptroller’s Office has contributed decisively, both in the past and today, to limiting the extent of illegal government actions and government corruption.

However, there is almost no substantive ex ante, real-time, or ex post evaluation of fiscal policy implementation and its compliance with the fiscal rule, of government spending (either mandatory or discretionary), and of the efficiency and effectiveness of government programs and tax collection efforts. There are simply very few resources spent by congress, political parties, think tanks, or academia in conducting systematic evaluation of fiscal policy and its implementation due to the absence of an independent FC and/or a think tank or institute that focuses on fiscal policy. The only exceptions in regard to this dearth of fiscal policy evaluation are some academic papers and some initiatives at the MoF to assess sporadically some partial aspects of fiscal policy.

Fiscal Committees and Fiscal Councils

Fiscal committees are temporary or permanent advisory bodies to the MoF that are entrusted with specific narrow tasks such as providing advice on institutional changes or investments of SWFs. Their recommendations may or may not be binding on the government.

Independent FCs (and budget offices) are permanent government or congressional agencies entrusted with much broader tasks. Their recommendations can be binding on governments, more often than those of fiscal committees.

Although fiscal committees and FCs have different tasks, the latter may include the following (Debrun and Kumar, 2007; Debrun, Hauner, and Kumar, 2009; Ter-Minassian, 2010; Calmfors and Wren-Lewis, 2011):

• Evaluation and validation of financial and macroeconomic assumptions for the budget;

• Provision of independent projections for the budget and government financial conditions, both for the base scenario and risk scenarios, for the short term and the long term;

• Provision of policy assessments and recommendations on fiscal policy and budgetary management, based on ex ante evaluation of whether fiscal policy is likely to meet its targets;

• Assessment and advice to the government and/or the legislature on the stance of fiscal policy, its long-term sustainability and optimality, and its macroeconomic effects;

• Assessment of and recommendations regarding policies for government asset and liability management;

• Monitoring of budget implementation and provision of recommendations for budgetary corrections in cases of deviations in budget execution; and

• Analysis of fiscal transparency.

Some governments (like Chile’s) have adopted advisory committees of the MoF that provide recommendations, both binding and not binding, on some aspects of the menu of possible tasks identified above.

Other governments have adopted advisory offices of the legislature to provide an independent analysis of the basis and consequences of fiscal policy and budgets of the respective governments. That is the case of the U.S. Congressional Budget Office, which was founded in 1974 (Rivlin, 2010), and the Parliamentary Budget Office in Canada, which was founded in 2008 (Levy, 2008), as well as similar offices in other countries, like Japan, the Republic of Korea, and Mexico.

Among the countries with some kind of FC are many members of the European Union (several with more than one FC), including Austria, Belgium, Denmark, Estonia, France, Germany, Greece, Hungary, Italy, Luxembourg, the Netherlands, Portugal, and the United Kingdom (Debrun, Hauner, and Kumar, 2009). Outside the EU, Japan and Sweden have fiscal agencies in place that provide tax advice. Debrun and Kumar (2007) provide some statistical evidence in support of the notion that FCs in the EU’s 25 member countries have contributed to fiscal discipline, especially when advice in regard to this is provided by an agency mandated by an ad hoc law. Yet the more recent fiscal crisis in several euro area member countries raises doubts regarding these findings.

More recently, and partly in response to fiscal crises, a rising number of countries (including France and the United Kingdom) have adopted or are adopting stronger FCs, based on an ad hoc law that grants them substantial degrees of government independence, strengthening their capabilities to provide independent assessment and advice. This new brand of FC—as well as some of the existing councils—tends to exhibit the following features:

Chile lacks an independent FC, but it has in place independent fiscal committees or expert groups: the Advisory Committee for Trend GDP of the MoF (ACTG), the Advisory Committee for the Reference Copper Price of the MoF (ACRCP), and the Financial Advisory Committee on Sovereign Funds of the MoF. Their role is limited to a consulting or advisory function, as stipulated by the 2006 Fiscal Responsibility Law.

The ACTG provides the MoF with projections for the rate of growth of capital, the labor force, and total factor productivity (TFP), which are used by the MoF to generate projections of potential GDP growth and the output gap, based on an MoF methodology. The ACRCP provides the MoF with projections of the international long-term or trend copper price. Current-year projections for the next year’s output gap and trend copper price are key inputs for the structural fiscal balance rule, which, as mandated by the Fiscal Responsibility Law, is key for determining the overall government budget envelope, that is, to set the levels of government spending, structural and actual government revenue, and hence the actual and structural government balance.

The three individual projections made by each of the 16 members of the ACTG and the single projection made by each of the 12 members of the ACRCP are binding for the budget. Each member provides projections that are averaged, after elimination of the two most extreme observations, to generate the MoF’s official estimates for the four variables. However, the MoF maintains significant discretionary power in determining the methodology (i.e., the equations and parameters) for setting how the structural fiscal balance rule and the four projected variables translate into budgetary projections. Although the MoF has been increasingly transparent about the details of its method, as reflected in technical papers, the summary notes of the ACTG and ACRCP annual meetings, and the 2010 Budget Law for 2011, this information also reflects remaining discretion maintained by the MoF in defining the government’s overall resource envelope.

Independent members of both of these advisory committees are invited by the MoF to serve for one budgetary exercise. Members are selected and designated by the MoF among the local communities of macroeconomists (for the ACTG) and copper market experts (for the ACRCP). They attend one technical meeting held at the MoF in July or August of each year and are then invited to submit their individual projections in the following weeks. Between August and October of each year, the MoF publishes two official notes, one for each advisory committee, that report individual and averaged projections and, in the case of the ACTG, potential growth and output gap estimates. There is no formal or direct communication by any of the two committees with congress or the press.

In contrast to the two previous committees, the Financial Advisory Committee on Sovereign Funds is based on a more formal institutional setup. The committee’s six independent members are selected by the MoF from among the local community of macroeconomists and financial experts, and their overlapping tenure is two years. The committee is composed of its chair (a president), a vice-president, and four additional members. The committee meets on average every six weeks at the MoF. Members are remunerated for their attendance at committee meetings. The secretariat of the committee is the international financial directorate of the MoF. Its head acts as secretary of the committee, and his staff (also present at committee meetings) prepares technical reports on international financial conditions and financial performance of SWF investments for each meeting. Committee members discuss financial developments and their implications for the performance of the funds, evaluate fund management by the CBC and meet occasionally with bank managers of the funds, and issue recommendations about fund investment policy and regulation to the MoF. It is very important to note that committee recommendations, in contrast to the projections submitted by the two aforementioned committees, are not binding on the MoF.

The committee issues a press communiqué after each meeting and publishes an annual report on the funds’ financial results and the committee’s investment policy recommendations to the MoF.

The Rule

Chile’s fiscal rule for the central government budget was developed in 2000 and implemented in 2001 by Finance Minister Nicolás Eyzaguirre and his main advisors. Although the rule has been subjected to several changes, its main features have remained unaltered. Therefore, it is now in its twelfth year of operation through three different administrations—the governments of presidents Lagos (2000 to 2006), Bachelet (2006 to 2010), and Piñera (since 2010), who is committed to its continuation through the 2010–14 term.

Chile’s fiscal rule aims at contributing to two policy objectives—fiscal sus-tainability and fiscal/macroeconomic stability. Fiscal stability is ensured by committing to a target level for the government’s CAB that is consistent with government saving needs (net of government investment). Fiscal (and possibly macroeconomic) stability is attained by committing to a government spending path that is consistent with cyclically adjusted government revenue.¹ Therefore, Chile’s CAB rule combines a partial application of the permanent-income theory to government spending with a target level for long-term government saving. Hence, the rule’s aim is to save during high-revenue periods in order to withdraw from the latter savings in bad times, over and above saving or dissaving a fraction of government revenue over the cycle, that is, the CAB.

Chile’s largest sources of government cyclical volatility (i.e., the budget’s largest sensitivity to cyclical variables) are nonmining tax revenue and mining tax and transfer revenue. The business cycle reflected in the cyclical component of GDP largely determines the cyclical behavior of nonmining tax revenue, whereas mining tax and transfer revenue is largely determined by the cyclical component of the prices of copper and molybdenum.²

Chile’s government spending, compared to that of other OECD countries, is relatively insensitive to the business cycle because of the small size of automatic stabilizers on the expenditure side, such as government-financed unemployment benefits or institutionalized public employment programs during cyclical downturns. Hence, the fiscal rule distinguishes between actual and cyclically adjusted government revenue, but not between actual and cyclically adjusted government expenditure.

Therefore, the fiscal rule is embedded in the following equation for the cyclical component of the government balance, that is, the difference between the CAB and the actual balance of the central government. This difference boils down to the difference between cyclically adjusted and actual government revenue, which is determined by the difference between cyclically adjusted and cyclical nonmining tax revenue and social security receipts (driven by the output gap), and between cyclically adjusted and cyclical differences in private mining tax revenue, CODELCO (the government-owned copper corporation) copper transfers to the budget, and CODELCO molybdenum transfers to the budget:

where

$B_t^{*}$	= government CAB,
Bt	= actual central government balance,
$R_t^{*}$	= cyclically adjusted central government revenue,
Rt	= actual central government revenue,
Gt	= actual central government expenditure,
${NMTR}_t^{*}$	= cyclically adjusted net nonmining tax revenues and social security receipts,
NMTRt	= net nonmining tax revenues and social security receipts,
MTRt	= actual tax revenue from private mining companies,
${MTR}_t^{*}$	= cyclically adjusted tax revenue from private mining companies,
CRt	= actual transfers from CODELCO copper sales,
${CR}_t^{*}$	= cyclically adjusted transfers from CODELCO copper sales,
MRt	= actual transfers from CODELCO molybdenum sales,
${MR}_t^{*}$	= cyclically adjusted transfers from CODELCO molybdenum sales, and
t	= time period subscript.

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$B_t^{*}$	= government CAB,
Bt	= actual central government balance,
$R_t^{*}$	= cyclically adjusted central government revenue,
Rt	= actual central government revenue,
Gt	= actual central government expenditure,
${NMTR}_t^{*}$	= cyclically adjusted net nonmining tax revenues and social security receipts,
NMTRt	= net nonmining tax revenues and social security receipts,
MTRt	= actual tax revenue from private mining companies,
${MTR}_t^{*}$	= cyclically adjusted tax revenue from private mining companies,
CRt	= actual transfers from CODELCO copper sales,
${CR}_t^{*}$	= cyclically adjusted transfers from CODELCO copper sales,
MRt	= actual transfers from CODELCO molybdenum sales,
${MR}_t^{*}$	= cyclically adjusted transfers from CODELCO molybdenum sales, and
t	= time period subscript.

Simple reordering of the identity part of equation (7.1) shows that the fiscal rule boils down to limiting actual government spending to cyclically adjusted revenue net of the CAB:

Cyclically adjusted (i.e., trend or long-term) variables are nonobservable, and therefore estimates of them are required for implementation of the fiscal rule. As discussed previously, estimates of nonobservables are outsourced annually to private sector commissions in preparation of the submission of the budget law and are finally approved by congress. Implementation of fiscal policy during the subsequent budget (i.e., calendar) year abides by the budget law and the fiscal rule.

There are three key elasticities in the fiscal rule. The first one is the output gap elasticity of nonmining tax revenue, which is explicitly reflected in equation (7.1). Until 2008, the MoF fixed this parameter at a value of 1.05, which implicitly assumes that nonmining government revenue varies almost proportionately to cyclical GDP. This aggregate elasticity was replaced in 2009 by separate elasticities for different categories of tax revenue, varying between 1.0 and 2.4 (Rodríguez, Escobar, and Joratt, 2009).

The second and third elasticities are the copper and molybdenum price elasticities of the three mining revenue items in equation (7.1). There are no explicit values attached by the MoF to the two latter elasticities. Instead, the Budget Office of the Ministry of Finance (DIPRES) produces annual estimates for mining tax and transfer receipts at actual and trend prices for both minerals.

Strengthening the Institutional Framework of Fiscal Policy

Developing the institutional framework for fiscal policy and budget planning and execution comprises five components:

• Fiscal responsibility law: Adopt a legal framework, specifying budgetary procedures and rules to strengthen fiscal policy transparency, accountability, and stability. Fiscal responsibility laws establish requirements for governments to state transparently their short- and medium-term policy objectives, to set short- and medium-term targets for fiscal flows and stocks, to provide transparent information on budget planning and execution to the legislature, to implement a fiscal policy conducive to fiscal stability and solvency, and to account ex post for fiscal policy execution and attainment of policy objectives.

• Financial management of the budget: The core elements for efficient budgetary management by the MoF comprise granting strong powers to the MoF on legal initiatives with budgetary impact and in budget decisions regarding other ministries and government levels, commanding a high technical capacity for budgetary planning, adopting modern accounting principles, ensuring an efficient process of legislative approval of the budget that limits the possibility of congressional amendments, and developing a large capacity for monitoring budget execution.

• Budget planning horizon: Extend budgetary planning from one-year to multiyear horizons.

• Fiscal policy accountability and transparency of budgetary information: For both economic efficiency and political legitimacy goals, accountability of fiscal policy and transparency in provision of information of government accounts should be improved significantly.

• External control and auditing: Countries should strengthen external control and auditing functions of fiscal policy, budget execution, and government accounts at three levels—congress, the government’s general comptroller or auditor, and fiscal councils and committees.

Adoption of a Fiscal Rule

Adoption of a fiscal rule based on a CAB is the key reform required to avoid a procyclical bias in fiscal policy and government spending. For noncommodity exporters, cyclical adjustment may be limited to domestic GDP shocks; for commodity exporters, however, it is key to add cyclical adjustments to price shocks for their commodities. As is the case in Chile, for most commodity exporters, the largest source of government revenue volatility is precisely the price volatility of their commodity exports, not domestic GDP volatility. Moreover, domestic GDP volatility is likely to be lowered (as has been the case in Chile) by adoption of a rule that accounts for both GDP and commodity price volatility.

A successful fiscal rule will have a positive impact on the stability of government spending and government programs, fiscal policy sustainability and credibility, and overall macroeconomic stability. To achieve success, the fiscal rule should satisfy the following conditions:

• Based on calculations and formulas that are relatively stable over time;

• Based on assumptions and calculations that should be made public, together with the relevant budgetary information, to be replicated by outsiders; and

• Part of an institutional environment that supports independent or unbiased provision of key economic and financial forecasts (such as that by independent committees or councils).

The actual formula for the fiscal rule will be country specific, and so will be the budget balance for which it is defined (total or primary), the government level to which it applies (central or general government), the degree of spending acy-clicality or countercyclicality, and the target level for the CAB.

Establishment of a Sovereign Wealth Fund

Fiscal rules that target CABs require an SWF in which government savings are deposited during booms and withdrawn during downturns. Such funds are particularly important in commodity-exporting countries, where they are typically invested in foreign currency investments that are held abroad as government revenue comes also in foreign currency from the revenue obtained by commodity-exporting firms.

SWFs should satisfy the following conditions:

• Effective and transparent corporate governance;

• Transparent information on the transfers between the budget and the SWF;

• Portfolio composition determined by maturity concerns (length of commodity price and GDP cycles) and the government’s degree of risk aversion; and

• Efficient portfolio management set according to transparent guidelines and closely monitored by the government and the public.

Establishment of Government Committees and a Fiscal Council

Specialized government or MoF committees set up with narrow tasks, such as provision of independent forecasts of key variables for the budget or a board for the SWF, and staffed by independent members are an efficient way to bring expertise and independence to the government, thereby strengthening fiscal institutions.

Moving beyond the latter committees, several advanced economies have put in place or are establishing independent FCs that have broader mandates to improve the quality of fiscal policy assessment, budget planning, and monitoring of budget execution. It appears that no commodity-exporting country has established an FC to date. However, FCs are particularly needed in countries with weaker fiscal institutions, where such councils could make a major difference. Among their potential tasks are the following: