Sound, sustainable government finances can play a crucial role in promoting macroeconomic stability and growth, but good fiscal policy is hardly static. Particularly in an age of inten-sifying globalization, it requires frequent adaptation in the form of policy adjustments and strengthened institutions. Intensifying globalization has sped up this process, and Fiscal Adjustment for Stability and Growth—a new IMF pamphlet—examines the major changes of the past 15 years and counsels a pragmatic approach. The pamphlet, which updates a 1995 publication, explores when adjustment is needed, how the fiscal position should be assessed, what makes adjustment successful, how adjustment should be carried out, and what types of institutions can help.
What has changed? For starters, globalization has become a defining issue, says James Daniel, one of the pamphlet’s coauthors. On the revenue side, for example, it is now much more difficult for countries to tax mobile factors of production (such as international businesses) at the high rates they once could. Globalization has also proved a double-edged sword for emerging market economies—providing far greater access to international capital markets but also punishing overly lax fiscal performance swiftly and severely.
For many poor countries that no longer have to service heavy foreign debts and can look forward to much more aid, the period ahead could be a golden opportunity. Fiscal policy can and should help countries meet their development goals. But, Daniel cautions, policymakers must be mindful of the checkered history of aid and the numerous possible pitfalls, including real exchange rate overvaluations that can undercut exports and productivity growth (“Dutch disease”), crowding out of the private sector, limited government capacity to spend money well, ramifications for governance and domestic revenue generation, and unpredictable and volatile flows, especially when aid gives rise to ongoing spending needs.
Lessons of experience
Following apparently successful efforts to subject monetary policy to more formal frameworks, such as inflation targeting, many countries in recent years have moved to constrain fiscal policy through fiscal rules and fiscal responsibility legislation. Should countries adopt limits on their deficits and debt, as the European Union did with its Maastricht Treaty?
Daniel, reflecting the view of the new IMF pamphlet, suggests that “the jury’s still out.” The Fund counsels countries to be pragmatic and see what works in their own circumstances. Still, there are some tentative lessons to be learned from the experience so far, he says. Chief among them is that fiscal responsibility requires a broad political consensus to be successful. Rules and laws are no substitute for political commitment.
Finally, the Asian and other emerging market crises of the 1990s taught the importance of balance sheet variables. It is critical not only to look at flow indicators, like the well-known fiscal deficit measure, but also to keep an eye on stock variables, such as government debt, and on details such as who holds the debt and what currency it is in. Tied in with this idea is the concept of fiscal risk. Country authorities would do well to be aware of contingent liabilities, like government guarantees, that may become costly when times are tough.
Copies, in English and French, of IMF Pamphlet No. 55, Fiscal Adjustment for Stability and Growth, by James Daniel, Jeffrey Davis, Manal Fouad, and Caroline Van Rijckeghem, are available free from IMF Publication Services. See this page for ordering details. The full text is also available on the IMF’s website (www.imf.org).
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