The operations of the public sector have far-reaching macroeconomic implications that affect the stability, growth, and structure of the economic system. Fiscal activities may also be an important source of shocks affecting a country’s level of employment, capital accumulation, and the viability of its external sector. These implications have been thoroughly analyzed, both theoretically and empirically, and an increasing body of economic literature has focused on the analysis of the fiscal impact on aggregate demand and on the level of absorption.

The operations of the public sector have far-reaching macroeconomic implications that affect the stability, growth, and structure of the economic system. Fiscal activities may also be an important source of shocks affecting a country’s level of employment, capital accumulation, and the viability of its external sector. These implications have been thoroughly analyzed, both theoretically and empirically, and an increasing body of economic literature has focused on the analysis of the fiscal impact on aggregate demand and on the level of absorption.

In many of these analyses—particularly those of a theoretical nature—the fiscal activities of the government, whether they are revenue collection, spending, lending, or borrowing, are generally defined in a fairly simple and straightforward manner. The concepts of revenue, expenditure, and deficit are taken to be unambiguous, and the coverage of the public sector has been, in many instances, rather arbitrary. Moreover, cross-country comparisons have not always considered country-specific conditions that may affect definitional concepts very significantly and, furthermore, many of these concepts have not been adapted in response to changing economic conditions.

Reality, however, is much more complicated than the usual paradigm that generates the assumptions underlying many of the economic analyses of fiscal policy. When departing from the abstract context of theoretical discussions, a policy-oriented economist or policymaker who attempts to measure a seemingly straightforward indicator of fiscal imbalance such as “the overall deficit of the government” is confronted with numerous practical issues that have to be resolved before an actual estimate can be derived. For example, how should “the government” be defined? Should it include local governments and extrabudgetary units? How should special funds, such as social security funds, be treated? How should revenue and expenditure be defined, and what specific items should be included? Should their definition be based on cash flows, commitment, or national account concepts? Should the prices used to value government revenue and expenditure be actual prices or alternative measures, such as shadow prices or domestic resource costs? Should grants received by the government be considered as government revenue or counted merely as part of deficit financing?

These complications regarding the actual measurement of fiscal imbalances have consequences that impinge not only on accounting procedures but on an overall evaluation of the direction and the stance of fiscal policies. Thus, depending on how it is defined, the overall government deficit could signal a significantly different thrust of the desirable fiscal policy stance. Similarly, the precise definition of the public sector could have important implications for the design of a consistent package of fiscal policies.

The staff of the Fiscal Affairs Department of the Fund have been concerned for a long time with this type of methodological issues, given their relevance for the operational activities of the Fund. The five studies collected in this volume reflect this concern and deal with some of the important practical problems that must inevitably be confronted when analyzing fiscal developments and formulating fiscal policy. Although these problems arise in any country, regardless of its stage of economic development or economic structure, most of the issues analyzed in this volume have grown out of the authors’ experiences in developing countries.

Since there is wide professional interest on this subject, both at the analytical and at the applied levels, the five papers are being presented in a unified manner. Although sharing a common theme, the papers have diverse focuses and have been prepared without prior intention to collect them in the present form. Once put together, however, the papers seem to offer a central message, which is the apparent inadequacy of pure flow concepts (such as deficit, revenue, and expenditure) in fiscal accounting and in economic analysis. The papers seem to suggest, rather strongly, that concern for conventional flow concepts should be supplemented by examination of stock concepts, such as financial and real assets, liabilities, and net worth, in order to generate more satisfactory measures of the fiscal impact on the economy.

In “The Effects of Inflation on the Measurement of Fiscal Deficits,” Tanzi, Blejer, and Teijeiro analyze the implications of inflation for the measurement of fiscal deficits, and the proper meaning of the deficit as a summary indicator of the economic impact of fiscal policy under inflationary conditions. They consider inflation’s impact on the deficit when it is used to evaluate fiscal performance over time, and when it is used as an indicator to compare fiscal policies across countries.

Inflation affects the fiscal deficit both through its impact on revenue and on the interest and noninterest components of expenditure. For a highly indebted government in a country with high inflation, the reduction in the real value of debt, which follows inflation, has important implications for the measurement of fiscal imbalance, particularly for the measurement of the required fiscal adjustment. When inflation is high, a large portion of interest payments on government debt could, in fact, represent amortization of the debt. The inclusion of amortization payments with interest expenditures would imply that the conventional measure of the deficit would overstate the size of the true fiscal imbalance and could lead to the requirement of an unnecessarily fast fiscal adjustment.

The authors consider, as a possible alternative measure, the operational deficit, defined as the conventional deficit less that part of the debt service that compensates debt holders for actual inflation (or, alternatively, as the primary deficit plus the real component of interest payments). They point out a number of practical problems in the measurement of this latter concept, which has been noted in various forms, in the government accounts of several Latin American countries, including the obstacles to the estimation of the expected rate of inflation necessary to derive the real component of interest payments.

The authors conclude that, although the operational deficit would be useful as a lower-bound estimate of the government deficit in a high-inflation country, exclusive reliance on it for policy purposes may not be justified, since it could understate the country’s required fiscal adjustment, particularly when the very source of high inflation could be the bank financing of the fiscal deficit.

In many instances, the fiscal deficit is defined only in terms of the deficit of the central government. Sometimes, the definition of the deficit is expanded to cover the whole non-financial public sector, including the central government, special funds (such as the social security system), local governments, and non-financial public enterprises. In many instances, however, important fiscal or quasi-fiscal activities are carried out by the financial public sector. Notably, central banks may perform a number of critical fiscal operations, such as the payment of explicit or implicit subsidies in the form of low-cost loans to the private sector, the selling of foreign exchange for private sector imports at an overvalued rate, and the offer of free exchange rate guarantees. In “Amalgamating Central Bank and Fiscal Deficits,” Robinson and Stella make a case for consolidating central bank quasi-fiscal operations with the operations of the government, in order to derive a more meaningful deficit measure that would better reflect the overall impact of government operations and that would enable a more precise evaluation of the magnitude of the required fiscal adjustment.

When central bank profits, or losses, are not transferred to, or explicitly funded by, government, the usefulness of the conventional measure of the overall deficit is weakened and the extension of the deficit measure to include the non-financial public sector does not solve the problem. This is so because, as the authors point out, quasi-fiscal lending by the central banks in many countries often involves a large implicit subsidy, which is not reflected in the measure of the consolidated non-financial public sector deficit.

The authors conclude that a modification in the measurement of the government deficit to include the impact of quasi-fiscal operations of the central bank would result in a significant improvement in both macroeconomic analysis and policy design in many developing countries where the central bank’s quasi-fiscal role is substantial.

Another important measurement problem arises from the time dimension of government operations. Lags in payments that go beyond the normal accounting period often occur in the collection of taxes and in government’s outlays and amortization of debt. Such public sector arrears pose problems in the interpretation and measurement of the fiscal deficit and fiscal adjustment. A reduction in the cash deficit could imply simply the forced financing of government expenditure by a buildup of arrears to suppliers and creditors. Similarly, an increase in the cash deficit could indicate merely a reduction in amortization arrears. In “Government Arrears in Fiscal Adjustment Programs,” Diamond and Schiller discuss the implications of government arrears for the analysis of fiscal developments and policy formulation. In particular, the authors discuss the distortionary impact of arrears on the measurement of the deficit and their potential adverse implications for the speed of fiscal adjustment.

Arrears problems have become important for an increasing number of developing countries, complicating not only the analysis of fiscal developments but also the design of fiscal adjustment programs. The authors indicate that the implications of arrears extend beyond their impact on government accounts since arrears may also have allocative and distributional consequences.

The authors point out that the consequences of government arrears depend critically on two factors: the extent to which arrears are anticipated and the extent to which creditors are constrained in their ability to neutralize the impact of arrears. An unanticipated increase in government arrears could trigger various attempts to hold back transfers of resources to the government and could even have adverse implications for the government’s tax collection efforts. Anticipated arrears could reduce the quantities of goods and services that government contractors are willing to supply at given prices, thus raising the government’s purchase prices. Both possibilities suggest serious adverse consequences of arrears for adjustment efforts.

Another complication in interpreting the fiscal balance arises from government efforts to privatize public enterprises. In “The Budgetary Impact of Privatization,” Mansoor analyzes the budgetary implications of government asset sales. It is widely believed that the privatization of loss-making public enterprises improves the fiscal balance by reducing the central government transfers that are necessary to subsidize these enterprises. The author acknowledges that this could indeed be the case, but points out that, for the fiscal position to improve, privatization must lead to efficiency gains in the economy, an important assumption that is not always warranted. The budgetary implications of privatization must be assessed by taking into account the budgetary impact of both the short-run and long-term consequences of privatization. Although asset sales reduce the conventional deficit in the year that the sales take place, the impact on the government’s permanent income or wealth may well weaken the government’s long-term budgetary position, unless privatization is accompanied by proper policy measures, such as deregulation and increased reliance on market forces.

The author emphasizes that the conventional deficit may be seriously inadequate as a measure of the government’s fiscal position when the size of the public sector is changing and suggests that the flow measure of the deficit be supplemented by other indicators, such as the net worth of the government or of the public sector.

The prices used to value fiscal operations represent another important source of possible distortions, when using the conventional measure of the government deficit as an indicator of fiscal imbalance. Such distortions may arise on both the revenue and the expenditure sides. The use of actual prices, when they are distorted, can give a drastically misleading measure of fiscal imbalance. For example, the use of an overvalued exchange rate in measuring government expenditure on imported goods results in an estimate of the fiscal deficit that understates the government’s actual use of a country’s resources. The use of other controlled prices, such as unrealistically low public sector wage rates and controlled procurement prices of other goods and services, may also distort the measurement of fiscal imbalance. In “Credit Subsidies in Budgetary Lending: Computation, Effects, and Fiscal Implications,” Wattleworth discusses an important source of such distortions in many countries—low-interest lending activities of the government.

Government lending activities can involve substantial implicit subsidies, which are not reflected in the conventional cash-based measure of deficit. More important, the implicit subsidies often persist long after the government’s lending activities are suspended, as long as the outstanding balances of the loans remain. Thus, any attempt to detect implicit subsidies from net lending activities alone, without due consideration of the implications of past lending, may be misleading. In fact, implicit subsidies may grow, though net lending activities are phased out. The methodology suggested in the paper is staightforward, simple, and practical to use, and its application is illustrated by numerical examples.