Abstract

There is a growing recognition that the design and implementation of economic policies depend to a considerable extent on the incentives of policymakers. It is also generally recognized that even well-intended governments may end up pursuing unsound policies. This may happen in part because incentives of policymakers change over time, with policies agreed to previously not being implemented. 1 It may also reflect the impact of the political environment, such as the influence of special interests or immediate electoral concerns, that generally results in short-time horizons. These factors have contributed to unsatisfactory fiscal performance in many advanced and developing economies (IMF, 2003).

There is a growing recognition that the design and implementation of economic policies depend to a considerable extent on the incentives of policymakers. It is also generally recognized that even well-intended governments may end up pursuing unsound policies. This may happen in part because incentives of policymakers change over time, with policies agreed to previously not being implemented.1 It may also reflect the impact of the political environment, such as the influence of special interests or immediate electoral concerns, that generally results in short-time horizons. These factors have contributed to unsatisfactory fiscal performance in many advanced and developing economies (IMF, 2003).

The emphasis on policymakers’ incentives has paved the way for institutional innovation expected to improve policy. A common objective of reform has been to reshape policymakers’ incentives. One way to achieve this is to delegate activities susceptible to “government failure” to independent agencies or to establish arrangements that raise the reputational and electoral costs of distorted policies. The case for delegation has been at the core of the recent developments regarding the independence of central banks and financial regulators. The success with delegation of monetary policy has led some to argue that analogous fiscal agencies could play a useful role in reducing undesirable tendencies, such as the emergence of unsustainable debt, policy procyclicality, and inefficient tax and expenditure policies.

This chapter examines the rationale for fiscal agencies, explores issues relating to their implementation, and reviews country experiences. These agencies could improve fiscal policy by exercising policy mandates explicitly delegated to them or by influencing the democratic debate through independent analysis, forecasts, or judgment. Their specific mandate and structure would depend on the nature of the fiscal policy problem and on the country’s policymaking environment. Hence, unlike the structure and role of independent central banks, which is fairly uniform across countries, the characteristics of fiscal agencies would be much more country specific.

The chapter identifies two types of fiscal agencies: Independent fiscal authorities (IFAs) to some extent mimic on the fiscal side independent central banks. For instance, they could be mandated with the objective of attaining a short-term fiscal balance target consistent with debt sustainability, and/or with output stabilization. They may also be provided with some discretion over tax rates or spending.

Fiscal councils (FCs) would not receive any specific authority over fiscal policy but would undertake analysis and assessment of fiscal developments and policies. They would essentially provide independent projections and analysis and thereby affect policymakers’ incentives through external scrutiny and democratic debate. They could also issue normative judgments, possibly involving formal procedures, such as a special session in parliament.

The chapter first develops an analytical framework for policy delegation in general and fiscal policy delegation in particular. Next, it discusses the potential roles of IFAs and FCs. Then it examines the experience with FCs and considers the complementary role that existing institutions—and especially the IMF—can play. The chapter ends by summarizing the main conclusions.

Delegation and Institutional Innovation

Given the scope for institutional innovation, what role could fiscal agencies play? They could help inform, analyze, assess, and implement fiscal policy.2 In one form or another their operation would entail some delegation from the elected representatives or their administration. This raises a number of issues. What are the general criteria for the delegation of policy or policy-related areas to new institutions? What do these criteria suggest specifically about the appropriateness of delegation in fiscal policy? What would be the types of institutions that could assume responsibilities in the fiscal area? These issues are examined below.

When Is Delegation Useful?

The proposition that institutional reform can improve the conduct of economic policy rests on two premises. First, institutions directly shape policymakers’ incentives that in turn affect policy choices; and, second, well-intended governments would be willing to adopt or modify institutions in a way that effectively improves policymaking. Nonetheless, reforms are in general likely to encounter resistance from entrenched interests: “All societies tend to see their current governing institutions as immutable, as if they were the natural order of things” (Blinder, 1997). In particular, reforms that entail delegation of policy mandates to politically independent, specialized bodies usually occur slowly and encounter stiff opposition. The evolution of institutions that are now generally taken for granted—independent judiciaries, central banks, or (financial) regulators—provides ample testimony in that regard.

Economic theory points to four basic criteria that should dictate whether it is desirable to delegate some or all aspects of policy (Alesina and Tabellini, 2003):

  • First, there must be socially harmful distortions in policymaking undertaken by political representatives. If there are no such distortions, there would be no gain from delegation, and the policy can be designed and implemented optimally by political representatives. In such circumstances, the other three criteria noted below would also not apply.

  • Second, there should be a broad consensus on what constitutes “sound policy” in any particular domain. This is essential to establish a mandate for which the independent body can be held accountable. The absence of such a consensus would indicate conflicts among social groups or constituencies. This would in turn suggest difficult policy trade-offs that only an elected body could legitimately resolve.

  • Third, delegated mandates should not be primarily distributive or have major distributive consequences. Clearly, distributional decisions should reflect a popular mandate that can only be exercised legitimately by the elected representatives.

  • Fourth, delegation should not give rise to major policy coordination problems. If a policy in a particular area or some aspect of it is delegated, it should not create conflicts with policymakers in another area that is not delegated. Otherwise, the coordination difficulties could outweigh any benefit from delegation. Likewise, delegation would be undesirable if there are significant economies associated with complementarities between prerogatives to be delegated and nondelegated ones.3

The delegation of monetary policy fits in fairly well with the above analytical criteria: (1) the politicization of monetary policy is generally perceived as a key source of macroeconomic instability; (2) there is relatively little variance in opinions about what constitutes sound monetary policy; (3) monetary policy is not primarily distributive; and (4) a clear-cut assignment of responsibilities between monetary and fiscal policies is in fact one way to deliver a well-coordinated policy mix (Box 6.1; see also Dixit and Lambertini, 2003). (Rogoff, 1985 first made a case for an independent “conservative” central bank that would preserve policy discretion and still reduce the inflation bias.)

At the same time, the above framework shows why structural policies are unlikely to be delegated to an independent agency. This is despite the fact that structural policies are often characterized by biases in favor of the status quo owing to political distortions (such as the action of well-organized special interests), and reflects the following: (1) there is no consensus on an ideal economic “model”—mainly because structural policies often involve difficult trade-offs between efficiency and equity; (2) structural reforms often have deep distributive implications; and (3) they have far-reaching implications for other policy areas.

Delegation of Fiscal Policy

With regard to fiscal policy, delegation might appear possible in some areas. The above analytical framework suggests that specific areas of fiscal policy particularly susceptible to government failure could be delegated to an independent agency. This concerns especially the overall fiscal balance, as supported by the four criteria elaborated above: deficit bias and procy-clical fiscal policies constitute socially harmful distortions in policymaking; there is broad agreement that sound fiscal policy should not create unsustainable deficits; the fiscal balance does not have direct distributional consequences, except across generations;4 and delegating the setting of the fiscal balance can reduce the problem of macroeconomic policy coordination, especially with monetary policy.

Comparing Monetary and Fiscal Policy Delegation

Fiscal agencies raise a number of issues in comparison with independent central banks. One can compare and contrast IFAs specifically with independent central banks.

The core objective for monetary policy is broadly recognized in most countries—price stability. Indeed, the costs of high inflation are felt quickly by large parts of the population, which boosts support for institutions supposed to prevent high inflation. However, what could be called the analogous objective for fiscal policy—debt sustainability—is less clear-cut. For one thing, high debt and deficits are likely to be less easily perceived as harmful by the general public. In the short and medium run at least, the costs of high deficits can be blurred by a number of factors: (1) large groups in the population might benefit from them; (2) the costs are potentially spread over a long time period; and (3) concerns about these costs could be deflected by an expected positive impact on economic growth.

Also, defining the goals of an IFA is more complex than defining those of central banks, owing to different characteristics of fiscal and monetary policy. This is despite the fact that the mandates of the two bodies can be comparable: IFAs could be mandated with ensuring debt sustainability and contributing to economic stabilization, compared with central banks mandated with ensuring price stability and contributing to growth.

Objective. The objective of monetary policy is usually an inflation rate within a prespecified range (with output stabilization sometimes added as a secondary objective). For fiscal policy, however, there is no broad agreement on one single objective. Unless fiscal stabilization over the cycle would be entirely dismissed, a fiscal agency would likely have to square two potentially conflicting objectives: fiscal sustainability and economic stabilization. Even if the IFA’s objective were indeed limited to debt sustainability ex ante, political pressure to pursue also a stabilization objective could get severe in bad times.

Target. The target of monetary policy is usually a certain interest rate or money supply growth. A natural target for fiscal policy would be the fiscal balance. However, there are at least three complications compared with monetary policy: First, the measurement of the fiscal balance is more complex and susceptible to “creative accounting.” Second—in contrast to the inflation rate—there is no broad consensus on a fiscal deficit that should not be exceeded. Third, fiscal policy generally works with longer lags than monetary policy: an IFA would have to decide on the fiscal balance several months before the new fiscal year.

Instrument. Central banks have a number of instruments at their disposal. However, what could be called the instruments of fiscal policy—tax rates and expenditures—would tend to remain under the control of the elected government.

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However, some other areas of fiscal policy should clearly remain under elected officials’ control. Specifically, those serving primarily distributive objectives, such as the progressivity of the tax system or the size of social transfers, are not good candidates for delegation. Even though political decisions on them might create economic inefficiencies, there is no broad consensus on what constitutes sound policy in these areas. Aspects of fiscal policy that are so highly dependent on social preferences should clearly remain under the control of the political process. (Nevertheless, there might be technical aspects of tax and expenditure policies where delegation could be considered, as discussed below.)

If delegation is deemed desirable, the following institutional arrangements need to be given specific attention:

Mandate. The agency needs a simple and unambiguous mandate, clearly related to the economic rationale for delegation—which is to effectively reduce fiscal policy biases. This facilitates the monitoring of the agency and enhances its accountability.

Discretion. The agency should be given complete discretion with regard to mandates delegated to it, and it should be able to use such discretion to fulfill its mandate.

Accountability. Ex post control procedures should allow elected officials to verify that the delegated prerogatives were used in accordance with the mandate. Sanctions against the agency can be envisaged if violations are detected.

Independence. There should be explicit guarantees against ex ante political control. That includes the prohibition for elected officials to issue instructions to the agency, specific appointment procedures for the agency’s executives, and provisions for a long-term budget allowing it to hire staff commensurate to the task in terms of both numbers and qualifications.5

Independent Fiscal Authorities

An IFA could reduce deficit bias and improve policy design and implementation. This could be achieved by providing IFAs with the mandate to decide on specific aspects of fiscal policy within a general policy framework previously defined through the political process. While no country has so far instituted a body similar to an IFA, a wide spectrum of proposals has delineated different mandates for such bodies.6 Alluding to the terminology familiar in the context of central banks (see Box 6.1), the proposals mainly differ according to whether the IFA would independently set an objective (e.g., debt sustainability) and a target of fiscal policy (such as the annual budget balance), or have some jurisdiction over one or more instruments of fiscal policy (e.g., tax rates). While no proposal envisages that all three aspects would be set by the IFA, some propose the IFA’s mandate to consist of a combination of targets and instruments (Figure 6.1).

At one end of the spectrum, an IFA could be mandated with setting both the long-term fiscal objectives and the annual targets for the budget balance (see Appendix 1). The IFA could, for example, be mandated to set a binding deficit target at the beginning of the budget process with a view to preserving long-term fiscal sustainability, given the economy’s cyclical position. The definition of the precise objectives, that is, a specific future debt level or the budget balance (over the cycle), would be left to the IFA (Eichengreen, Hausmann, and von Hagen, 1999). While the individual revenue and expenditure plans in the budget would continue to be decided through the political process, parliament would only be legally allowed to pass the budget if the target set by the IFA was reached.

Figure 6.1.
Figure 6.1.

A Taxonomy of Fiscal Agencies

Source: IMF staff.

Some more limited proposals envisage IFAs mandated to prescribe budget targets within a politically prespecified framework of fiscal policy objectives.7 The IFA could be mandated to set a binding budget target with a view to reaching a future debt level or a certain budget balance over the cycle prespecified through the political process. While some proposals focus on the IFA’s contribution to debt sustainability (Wyplosz, 2005), others concentrate more on the need to pursue countercyclical fiscal policy (Calmfors, 2003). Ultimately, however, an IFA would necessarily have to be concerned with both sustainability and cyclicality, as they cannot be fully separated.

In the same vein, an IFA could be instituted as the impartial enforcer of an existing fiscal rule. The IFA could, for example, be mandated to veto any budget proposal at odds with the fiscal rule. The more economic analysis the implementation of a rule requires, the more important the value added of such an IFA could be. For instance, while a balanced budget or “golden rule” is relatively clear-cut, the assessment of any rule that has to be met over the cycle requires considerable expertise, which can weaken implementation. In such cases, the rulings of the IFA could be particularly useful.8

Although an analytical case for IFAs can be made, their establishment appears unlikely for a number of reasons. First and foremost, the institution of an IFA raises issues of democratic accountability that are much more serious than those pertaining to independent central banks.9 Second, there is a risk that conflicts between the IFA and the government could undermine policymaking: for example, in-year adjustments to the budget (due to unforeseen events) would require close cooperation between the IFA and the government; in countries with substantial fiscal decentralization, an IFA would need also close coordination with subnational governments. Third, policymakers are reluctant to delegate a significant part of their mandate (particularly given that monetary policy often is already independent). In sum, these concerns are likely to explain why there are to date no IFAs in operation in any country. This strengthens the view that similar but less intrusive fiscal agencies could play a useful role in promoting fiscal discipline. These are discussed in the following section.

Fiscal Councils

FCs could help reduce the deficit bias while leaving discretion to the political representatives. They could contribute to greater transparency and therefore accountability of fiscal policy and thereby raise the political cost of inappropriate uses of fiscal policy in terms of credibility of the policymakers. A variety of FCs have been in operation in a number of countries. They range from organizations essentially mandated to provide independent projections of budgetary variables and general fiscal analysis to bodies assessing the consistency of a government’s budgetary policies with its own long-term objectives or proposing specific fiscal adjustment measures in the context of fiscal rules.

Mandate

Existing FCs can be broadly categorized into three types (Figure 6.1). The first type has a mandate to provide objective analysis of current fiscal developments, their macroeconomic context (such as the cyclical position of the economy), long-term sustainability considerations, and costing of budgetary initiatives. The second type provides independent projections and forecasts. The third type, in addition, has the mandate to provide normative assessments. This includes, for example, the appropriateness of fiscal policy in a given macroeconomic environment, or a recommendation of a particular fiscal stance for a given year within a medium-term framework previously defined through the political process.

A number of proposals in the literature describe arrangements essentially similar to those noted above (Table 6.1). Most often, they propose a strengthening of the commitment to existing fiscal rules through an FC type of institution.10 Such an institution would typically assess budgetary performance relative to fiscal rules and might also be mandated to suggest adjustments if necessary. The proposals are mostly centered around debt sustainability, although some also envisage a role for the FC in stabilization, whereby it could issue statements on the appropriateness of the fiscal stance from a cyclical perspective.11

Table 6.1.

Selected Proposals for Fiscal Councils

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Some proposals go a step further and suggest combining an FC’s assessment of the observance of fiscal rules with sanctions imposed by the judiciary. For example, De Haan, Bergen, and Jansen (2004) propose in the context of the European Stability and Growth Pact that the European Commission should issue binding decisions on the fiscal adjustment needs for the EU member countries. Noncompliance with these rulings by the governments would entail sanctions to be imposed by the European Court of Justice.12 The effectiveness of the FC, in this case the European Commission itself, would stem from the legal consequences of noncompliance with its decisions. However, the role of the FC in these proposals should not be overstated: ultimately, the idea is to make fiscal rules that were established through the political process legally binding like any other constitutional provision.

Some propose the independent preparation of fiscal and macroeconomic forecasts by an FC.13 Without presuming that independent forecasts would be technically better, these proposals are motivated by the concern that policymakers may utilize biased economic forecasts underlying the budget to obfuscate policy intent and limit ex ante public scrutiny (see also the section below, “Can Other Institutions Play the Role of Fiscal Agencies?”). To the extent that biased forecasts contribute to excessive deficits, independent forecasts could improve fiscal performance. The FC would prepare forecasts on a continuous basis that would increase the transparency of the budget and of fiscal performance throughout the year. Different from private sector or academic forecasters, the FC would be mandated by the government and would thus have access to inside information. The forecasts could be revisited during the year to adjust the fiscal stance where needed (see the Chilean example in the section “Can Other Institutions Play the Role of Fiscal Agencies?”). While the ultimate decision on the budget forecasts could be left to the government, the impact of independent forecasts on fiscal discipline would be enhanced if their use for the budget were made mandatory. This type of FC could make a constructive contribution to promoting fiscal discipline.

Implementation Issues

The proposed institutional setups for FCs vary, but autonomy is a general consideration (Table 6.1). As for IFAs, most proposals envisage that FCs would consist of economic policy experts from academia and the public sector, whose autonomy could be bolstered by a number of provisions, not unlike those in place for many independent central banks.14 As a special case, two proposals (Inman, 1996; and De Haan, Berger, and Jansen, 2004) envisage a role for the judiciary in strengthening compliance with fiscal rules. Accountability is less of a concern for FCs than it is for IFAs, but nonetheless it could be enhanced if FCs were instituted by parliament and required to explain recommendations in detailed public reports. Moreover, an FC’s influence in the debate would depend on the credibility of its assessment.

Whether an FC is likely to make a significant contribution to policy will depend in part on the severity of the fiscal problem in a given country. A political system with a fair amount of credibility and manageable slippages may prefer a relatively limited mandate for an FC, that nonetheless still enhances public scrutiny of policies. However, countries demonstrating a serious deficit bias under discretion and low credibility might consider a more significant move with the FC given the authority to provide normative assessments that the government feels obliged to take into account.

The institutional environment in a given country is also likely to determine the shape and effectiveness of FCs. Its effectiveness will depend on the importance of accountability in a country’s institutional setup, as enshrined in its constitution. When checks and balances are strong, an FC with a mandate limited to analysis could usefully lend support to the more fiscally responsible parties. But where checks and balances are weak, such an FC is more likely to be ignored in the political process.15 Substantial fiscal decentralization might raise the potential gains from an FC, as it could assume the role of an independent arbitrator between the central and the subnational governments and contribute to the coordination of fiscal policies (see the Belgian example discussed in the section “Can Other Institutions Play the Role of Fiscal Agencies?”). At the same time, such decentralization could complicate the FC’s mandate as it would have to monitor the fiscal policies of the local governments as well.

A number of conditions could bolster the effectiveness of an FC. Given that it would exert influence primarily through the public debate, two main conditions are crucial: (1) its mandate needs to be clearly defined and reflect a relatively broad social consensus on what constitutes sound policy;16 and (2) the government must be willing to integrate the FC into its work—perhaps even by using it to bolster its case for unpopular measures or reforms. Additional conditions that could strengthen the effectiveness include (1) the existence of fiscal rules, because they provide a clear benchmark against which the government’s policies can be assessed; (2) a central role for the FC in the budget process—for example, the budget vote could require a hearing with the FC or an explanation from the government if its recommendations are ignored; and (3) legislated provisions regarding the FC, because they could bolster its position in a possibly unfavorable political environment.

Experience with Fiscal Councils

This section reviews the experience with FCs in a number of countries. It yields four main lessons. First, the establishment of an FC is a realistic institutional reform that seems to have contributed to fiscal discipline in a number of countries. Second, FCs providing normative assessments of fiscal policy appear to have been more effective than those limited to nonnormative analysis. Third, the effectiveness of either hinges on the government’s commitment to fiscal soundness. If a certain degree of commitment exists, it can be bolstered by an FC; if not, its impact is likely to be limited. Fourth, the desirable mandate and setup of FCs should be country specific, depending on the nature of the fiscal problems, the existence of fiscal rules, the role of the legislature in the budget process, and the checks and balances existing in the political process.

There are several examples of FCs with a mandate to issue normative judgments regarding a government’s fiscal policy and assessment of whether it is consistent with its own predefined goals. In the process, these councils undertake independent analysis of fiscal developments, as well as provide forecasts and projections for macroeconomic variables.

Belgium—The High Council of Finance

Belgium established an “independent fiscal council” in 1989 in the context of a substantial fiscal decentralization reform. The aim was to provide a coordinating mechanism for general government fiscal policy to secure macro-economic stability. The council was officially established as the “Public Sector Borrowing Requirement Section” of the already existing “High Council of Finance.” (The other sections are “Taxation and Social Security Contributions,” “Transfer of Federal Collected Tax Revenues,” and “Financial Institutions and Markets,” and a “Study Group on Ageing.”) The council complements the role of the Federal Planning Bureau, which is a relatively independent government body and provides independent economic forecasts that must be used for official purposes, long-term forecasts, and policy analysis.

Belgium’s council has a relatively strong mandate. First, it publishes two yearly reports: (1) in March, an assessment of the implementation of the internal stability program during the previous year; and (2) in June, an analysis of the borrowing requirement of each of the local governments, as well as the budgetary policy to be adopted, including specific recommendations on the budget balances of the three levels of government. Second, the council may give its opinion, on its own initiative or upon request of the federal finance minister, regarding the advisability of restricting the borrowing requirement of governments due to considerations about short- or long-term macroeconomic stability.

However, the council is explicitly limited to commenting on the borrowing requirement. It must not comment on general fiscal policy (particularly tax and expenditure policies) or social and economic policies in a wider sense. Still, it can make reference to a broad range of issues in the context of its recommendations pertaining to fiscal sustainability, including politically sensitive issues such as expenditure pressures arising from aging. In its assessment of the fiscal stance and its recommendations, it is guided by the long-term fiscal frameworks agreed between the different levels of government.

The council is composed with a view to equal representation and independence. Its 12 members are appointed by the king upon proposal by the regional governments, the central bank, and the ministry of finance. The chairman (from its inception) is an academic. Six members each have to come from the Flemish and the francophone community, respectively. The members are appointed for renewable five-year mandates. They have to be economic experts and must not hold a political office at the same time, to ensure their independence. Recommendations by the council have to be supported by a majority of its members.

The council’s recommendations were followed closely as long as its views were aligned with political priorities. During the 1990s, the council was charged with monitoring the implementation of the government’s “convergence plan” that envisaged reducing the fiscal deficit to the Maastricht criterion of 3 percent of GDP by 1996. During that period, its recommendations for the deficit were closely adhered to and—according to anecdotal evidence—contributed to the substantial fiscal consolidation during that period. Since the downturn in 2001, however, the council’s recommendations seem to have been followed less closely. The downturn provided the context for a downward revision of the medium-term consolidation plan for 2001–05. However, even the council’s recommendation for meeting these revised targets was not fully implemented. As a consequence, the budget outcomes, adjusted both for the cycle and one-off measures, were negative at the general government level over the period 2001–04 (Van Rompuy, 2005).

ch06ufig01

Belgium: Government Net Lending

(In percent of GDP)

Source: Organization for Economic Cooperation and Development.

Belgium’s High Council of Finance recommends specific annual borrowing requirements for all levels of government (Box 6.2).17 Each year, the council publishes two reports: one on the future public sector borrowing requirement and another on the implementation of the Belgian stability program. The council’s mandate is explicitly limited to the borrowing requirement, but it provides recommendations on the requisite fiscal stance for all levels of government consistent with that requirement.

Denmark’s Economic Council provides judgment on fiscal and structural policies and recommends changes.18 Its analysis is based, among others, on its own economic forecasts for the subsequent two to three years. The council’s semiannual reports are produced by its three independent chairs.

The composition of these FCs varies considerably, ranging from specific representation to loose expert panels. In Belgium, the federal finance ministry, the central bank, and the regions are represented on the agency, reflecting the council’s role in policy coordination in the context of substantial fiscal decentralization. These representatives cannot hold political posts at the same time. In Denmark, in addition to independent experts, the council has 26 members representing trade unions, employers, the central bank, and the government; the three chairmen (“wise men”) are generally academics.

The evidence suggests that these agencies have made an effective contribution to fiscal discipline in their respective countries. Although it is difficult to disentangle their impact from that of other factors, the recommendations of these agencies seem to have been taken seriously, with the respective governments adhering to them in many instances. These agencies have helped make the process of fiscal policy formulation and implementation transparent and contributed to a constructive public debate on budgetary issues. This, in turn, has often helped highlight the requirements for sustainable policies and strengthen the governments’ ability to implement them. For instance, in Belgium, the council’s recommendations on the borrowing requirement were followed particularly closely for a number of years during the 1990s, and allowed some difficult consolidation measures to be implemented. In addition, the council’s recommendations have served as a useful basis for multiannual cooperation agreements between different levels of governments.

The experience with these agencies also highlights the role of political environment, and usefulness of rules. In both cases, the agencies’ establishment reflected a political will and social consensus to stabilize or consolidate the fiscal position. Under such circumstances, these agencies reinforced credibility of commitment by increasing the political cost of deviating from responsible fiscal policies. In addition, there was a quite marked complementarity between “judgment” (entailing discretion) and rules. For instance, in Belgium, the agency’s recommendations were adhered to by the government because the need for adjustment was enshrined in a transparent rules-based framework. This underlines the contention that a clear standard against which the government’s policies can be assessed, particularly if it has been set by the government or parliament itself, may enhance the effectiveness of an FC.

A number of countries have delegated the preparation of economic assumptions and projections underlying the budget to independent bodies.19 Studies have shown that, if produced by the government, these assumptions and forecasts (typically for GDP growth, inflation, interest rates, unemployment, and tax revenues) can be susceptible to systematic overestimation or underestimation.20 While all forecasts—whether produced by the government or an independent body—are prone to errors (Table 6.2), independent forecasts would eliminate systematic, politically motivated biases. In the short run, such biases can make the budgetary situation look rosier than it is in fact, allowing governments to avoid making difficult choices. Over time this exacerbates fiscal vulnerabilities. Projections prepared or scrutinized by independent bodies could contribute to reducing these potential biases. For example, in Canada, a panel of independent experts from academia and the private sector is polled for macroeconomic forecasts. These experts underestimated the strength of Canada’s economy since the mid-1990s, which contributed to a string of larger than expected fiscal surpluses in recent years.21 In Chile, two independent expert panels help enforce a structural balance rule (Box 6.3). In the budget process, the two panels forecast copper prices and the growth of the labor force, real investment, and total factor productivity.

There are several examples of existing FCs with a mandate limited to impartial analysis of the government’s policies and their consequences.

The U.S. Congressional Budget Office (CBO) advises Congress and the public on a range of fiscal issues. It analyzes the president’s budget based on its own assumptions, “scores” new legislative proposals, and produces a large amount of ad hoc reports. The scoring or budgetary costing of specific initiatives has played a role in the decisions on whether such initiatives were adopted (Box 6.4).

Table 6.2.

Economic Assumptions in the Budget

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Source: OECD and World Bank (2003), based on self-assessments by governments.

Budget forecasts higher than actual performance in 2001 and 2002.

Chile: The Interaction of Fiscal Rules and a Fiscal Agency

Recent changes in Chile’s fiscal institutional setup have been consciously designed to further buttress fiscal sustainability and help dampen the effects of cyclical fluctuations. Since 2001, policy has been based on the rule of maintaining ex ante a structural surplus of 1 percent of GDP for the central government. According to the rule, fiscal expenditures follow the dynamics of structural revenue, that is, the revenue that would be achieved if the economy were operating at full potential, and the price of copper (Chile’s main export) were at its long-term level.

To strengthen the implementation of the rule, the projection of the inputs into the trend GDP estimate and of copper prices was delegated to two independent expert panels. The panelists estimate individually the growth of the labor force, real investment, and total labor productivity. The estimates are then averaged eliminating the two most extreme values and used by the finance ministry to estimate trend GDP through a production function approach. Such a methodology is likely to avoid under or overestimation or underestimation of potential GDP: a downturn in the pace of activity is likely to impart a downward bias to the potential that is likely to result in a more expansive policy while a rebound is likely to go in the opposite direction. In addition, a second panel produces 10-year forecasts of the price of copper which are also averaged excluding the two most extreme values.

Despite a largely technical mandate, the panels play a key role in the budget process. The combination of the structural balance rule and the independent panel was adopted to signal policy credibility, while at the same time maintaining some policy flexibility. Together they aim to give more stability to public expenditure preventing excessive adjustments in periods of recession or unsustainable expenditures during boom years. The panel’s role ensures that the underlying economic assessment is separate from other considerations in the budget preparation and implementation.

Japan’s Fiscal System Council advises the finance minister on topics related to the budget and the government accounting system. It comments on the budget requests and makes proposals for the measures to be taken for the following fiscal year. Furthermore, it conducts research on and recommends measures in the areas of fiscal structural reform (such as expenditure rationalization) and the government accounting and budget systems.

In Germany, the “Working Group on Tax Estimates” publishes regular estimates of government revenues. It consists of government officials, academics, and representatives of the Council of Economic Experts and has a reputation of relative independence.22

Box 6.4. United States: The Congressional Budget Office

The Congressional Budget Office (CBO) was established in 1975 to inform the U.S. Congress on fiscal issues. As part of a comprehensive reform, it was intended to contribute to compliance with the then newly created congressional budget process. Both were designed to give Congress the capacity to act independently of the president on revenue and spending matters. Its mission is “to provide the Congress with the objective, timely, nonpartisan analyses needed for budget and economic decisions and with the information and estimates required for the Congressional budget process.” In doing so, the CBO produces a large number of reports and its senior staff regularly testifies before Congress.

The CBO plays a key role in the annual budgeting process and in budget monitoring. Particularly important is the annual analysis of the president’s budget, including its reestimation using the CBO’s economic and technical assumptions. Further tasks include cost estimates of bills reported by congressional committees and estimates of unfunded federal mandates, which impose costs on state or local governments. During the dozen years that the Budget Enforcement Act was in effect, the CBO also reported to Congress on the status of spending limits and any required offsets.

As an important input into its advice on the budget, the CBO produces two macroeconomic forecasts each year. They cover GDP, unemployment, inflation, and interest rates for the next two calendar years. In preparing the economic projections, the CBO is guided by a panel of economic advisors. The CBO also produces 10-year baseline projections of macroeconomic trends and federal revenues and expenditures.

The baseline projections serve as the starting point for measuring the impact of policy changes on future budgets (“scoring”). The baseline report is updated each summer to reflect fresh estimates of economic conditions and recent policy changes. In explaining variations from the previous baseline projection, the CBO classifies changes into three categories: policy changes, such as new legislation; economic changes, such as higher or lower GDP growth; and technical changes due to reestimates of future receipts or expenditures.

The “scoring” task of the CBO has tended to be one of the more important roles. This role gained prominence in the 1990s because of the rules existing then requiring mandatory spending increases and revenue reductions to be offset. The amount of the offset depended on the CBO score. If, for example, the CBO scored tax legislation as a $10 billion reduction in revenue, Congress had to compensate for that estimated loss by raising other revenues or reducing mandatory spending by an equivalent amount.

The CBO has a reputation of independence. Its director is appointed jointly by the House of Representatives and the Senate and can be removed by either house of Congress. However, the Budget Act provides that the director and staff are to be appointed “without regard to political affiliation and solely on the basis of their fitness to perform their duties” and the operational independence of the CBO, while not enshrined in law, appears to have been generally respected. As Schick (2004) notes, the “CBO has never openly asserted its independence from Congress, for doing so would undercut its legitimacy and alienate it from its patrons. Yet it has behaved in ways that manifest its independence on the political scene. For the CBO, independence is more a matter of organizational culture than of legal status.” The CBO’s staff numbers about 230, about one-third of whom are assigned to the largest division, budget analysis. Most of the remaining staff work in the program divisions that deal with macroeconomics, taxation, microeconomics and finance, long-term models, health and human resources, and national security.1

1 For further information, see the CBO’s website (www.cbo.gov) and, for example, Schick (2004) and Blöndal, Kraan, and Ruffner (2003).

The Central Planning Bureau (CPB)23 of the Netherlands conducts independent analyses and provides the economic assumptions for the budget. It conducts research on a broad range of economic issues, including fiscal, labor market, and regulatory policies. The CPB also plays a role in the development of the budget policy contained in the coalition agreements. All political parties use the CPB’s economic assumptions for their policy platforms, and the larger parties submit their platforms to the CPB ahead of elections for assessment. After the elections, the CBP assesses compromises negotiated for coalition agreements.

Korea’s National Assembly Budget Office24 advises parliament on fiscal policy issues. It analyzes budget and economic policies, evaluates general fiscal policies and national programs, and conducts research. The budget office also produces cost estimates for bills and forecasts of fiscal and macroeconomic trends. The head of the budget office is advised by the Budget Policy Advisory Committee, which includes members from the financial sector, universities, and the media.

Mexico’s Center for the Study of Public Finances,25 modeled on the U.S. CBO, is attached to the congress. It reviews the periodical government reports on the economic situation, the public finances and public debt, as well as the budget proposal and fiscal laws. It also provides independent analyses requested by the congress or upon its own initiative.

A number of other countries have fiscal advisory bodies attached to the legislature. In addition to Korea, Mexico, and the United States, Canada, Chile, Indonesia, Japan, Jordan, the Netherlands, and Sweden have “specialized budget research organization(s) attached to the legislature (or the audit office) that conduct analyses of the budget” (OECD and World Bank, 2003). They have generally less than 10 professionals who are part of the legislature’s general support staff.

FCs can have varied structures. They can range from a small group of academics to a full public agency with extensive technical and financial resources as in the U.S. (see Box 6.4). In Mexico and the United States, the council is attached to the legislature, only the respective director is appointed by congress. In Japan, the council is an organ of the ministry of finance and is composed of scholars, journalists, and business executives. In Chile, the two panels of 12–14 members each are appointed each year.

The experience with these FCs appears to suggest that their effectiveness depends even more than for those with stronger mandates on the government’s commitment to fiscal prudence. Fiscal performance has varied substantially both across countries and across time despite their existence. This suggests that the political cost of ignoring the analysis of a purely advisory body is generally limited. The cost is likely to be smaller than ignoring normative assessments and recommendations, because the latter provide a benchmark against which the government’s policies can be scrutinized in public forums. The more open-ended the advice, the less it is likely to have weight in the political and public debate.

Can Other Institutions Play the Role of Fiscal Agencies?

A number of existing institutions—most notably central banks, private financial institutions, and regional or multilateral institutions—already help shape policymakers’ incentives in ways that discourage the abuse of discretionary fiscal policy. However, for a variety of reasons noted below, they cannot fully substitute for fiscal agencies. In particular, they are either not independent or do not have a domestic government mandate, as an ideal FC would. Rather, FCs and the existing institutions could complement each other.

Where a nascent FC already exists, strengthening it may well be preferable to the setting up of a new institution. For example, a well-established and reputable policy institute could be provided with a formal mandate to systematically undertake analysis of budgetary issues and to issue regular reports on the government’s policies. There could also then be a mandatory requirement on the part of the government to respond formally to its reports. These reports of course need not be restricted simply to analysis, but could include also normative assessments, and recommendations (for instance in the “green budget” produced by the Institute for Fiscal Studies in the United Kingdom). A prerequisite for credible operation of such an institution is the provision of a formal mandate, as well as accountability.

In many countries, national central banks could—and to a certain extent already do—act as an FC. Central banks often enjoy political independence, are granted an autonomous budget, and have a staff able to analyze and assess fiscal policy issues as well as influence the policy debate. As the government’s bank, the central bank is also well placed to monitor fiscal flows and stocks. Granting the central bank a well-defined fiscal mandate could thus save the costs of creating a new institution, and make sure that the “embedded” FC is credible. However, there is a danger that a central bank will be too narrowly focused in its approach to fiscal policy. This could in turn elicit a response from the government that threatens the independence of the central bank. Moreover, the concentration of policy-related mandates in the hands of unelected representatives would magnify issues of democratic accountability.

Private financial institutions, such as commercial and investment banks, as well as rating agencies, also provide independent assessments of fiscal policy. Their influence on policy outcomes works through market pricing of government and quasi-government securities. However, there are two key reasons why these institutions are unlikely to be able to substitute for FCs. First, their motivation and incentives, based on profit considerations, and lack of democratic legitimacy, imply that they will not be guided by public policy considerations. Private sector research is arguably subject to its own bias, and distortions. Second, the transmission channel from the assessment to policy decisions is not the continuous democratic policy debate, but the discontinuous, and often sharp, delayed reaction of financial markets. Conversely, FCs can increase the flow of their information about fiscal policy, improve policy outcomes, and stabilize expectations, leading to smoother functioning financial markets.

Regional or multilateral institutions, such as the OECD and, in particular, the IMF, also undertake tasks similar to those of fiscal agencies. The appropriate role for the IMF will depend on whether it is providing financial support to a country or is engaged in surveillance. Where it exists, a fiscal agency and the IMF could play complementary roles in the context of an IMF-supported program. In this case, an independent fiscal authority (IFA) would have a mandate that is close to that of the IMF, although even an FC could facilitate the negotiation and implementation of a program by increasing the information flow between the authorities and the Fund, and by strengthening ownership of a program at the national level by shaping the desirable preconditions in terms of consensus, fiscal rules, and budgetary framework. The basic premise would be that the fiscal agency would have a realistic and objective view of the constraints facing the economy, and the policies that need to be implemented. There is, however, always a risk that an additional actor may end up further complicating the interaction between country authorities and the IMF.

In a surveillance context, an FC and the IMF play similar roles, in that they are both involved in the analysis of fiscal developments and sustainability. In this context they can support one another, rather than duplicating each other’s work. Thus, an FC should engage in a continuous assessment of fiscal developments, and undertake more detailed analysis of fiscal developments than is realistic for the IMF. The IMF, on the other hand, can provide a better perspective on the implications of broader international and global developments, as well as bring a cross-country perspective to bear on national fiscal policy.

Conclusions

This chapter has examined a number of issues related to the rationale, mandate, and operations of fiscal agencies and analyzed country experiences. The discussion points to the following conclusions.

There are widespread difficulties in the design and implementation of fiscal policy in both industrial and developing economies. They are reflected in deficit bias, procyclicality, and conduct of unsustainable policies. These problems arise from a variety of political and economic factors, but political economy considerations, including electoral concerns, and the competing demands from various constituencies and lobbies play a key role.

A major element underlying the above problems is the inappropriate use of discretion in fiscal policymaking. In general, discretion is valuable and allows response to unexpected shocks, as well as the exercise of the democratic mandate, particularly with regard to redistribution issues. However, discretion can be misused, especially in the presence of political and distributive conflicts, and if governments have short-time horizons. The challenge is to alleviate the undesirable features of discretion while retaining flexibility.

Institutional reform is one way of meeting that challenge. Whether as a complement to existing fiscal rules, or independently of them, institutions can be set up that help in the formulation and implementation of sound fiscal policies. Reforms in this direction could in general entail some measure of delegation of a policy mandate or of activities supporting such a mandate. Theory has identified various factors, including a consensus on what constitutes sound policy, that suggest that, in practice, delegation in fiscal policy could be beneficial.

There are two main types of fiscal agencies to which some aspect of policy could be delegated and which could help improve fiscal discipline: IFAs could be mandated with setting annual targets for the budget balance, or could veto proposals at odds with a given fiscal rule. However, while an analytical case can be made for IFAs, the fact that there are no instances of IFAs to date suggests that policymakers are reluctant to delegate a significant element of their mandate and that their implementation may raise issues of democratic accountability.

FCs are likely to be more generally acceptable and could help reduce policy distortions. These councils could help improve fiscal policy by independent analysis, forecasts, or normative judgments. They could thereby affect policymakers’ incentives and motivations, including through public debate and scrutiny. A number of countries have constituted FCs, and there are a variety of proposals for new ones. The evidence suggests that FCs providing assessment generally contribute more to fiscal discipline than those limited to pure analysis.

The desirable form of fiscal agencies is country specific. It would depend on the nature of the fiscal problem and on the country’s political environment, including the constitutional setup, the legal tradition, and policymaking customs. Fiscal agencies can complement the role played by existing institutions, including the Fund, and enhance their effectiveness. As part of the IMF’s mandate, consideration could be given to exploring the development of specific types of fiscal councils.

Both theory and experience suggest that fiscal agencies can improve the quality of fiscal policy. In particular, they can help improve fiscal discipline and policy credibility, and serve a useful signaling role conducive to more stable expectations and less uncertainty. But institutions of whatever shape are not a panacea: their effectiveness ultimately rests on a government’s commitment to the mandate assigned to them.

Appendix 1. Selected Proposals for Independent Fiscal Authorities

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1

This is the familiar problem of time inconsistency.

2

Several countries already have such institutions that play varying roles in helping increase the transparency and credibility of fiscal policy. The practices of these countries are examined in the section “Experience with Fiscal Councils.”

3

Some observers also point out that delegation is particularly useful in cases where policy choices involve a lot of technical expertise with respect to other dimensions of the decision process (e.g., Blinder, 1997; and Alesina and Tabellini, 2003). However, this does not appear to be a key discriminating criterion, as most well-designed economic policy decisions arguably require a significant input from highly skilled professionals.

4

Intergenerational redistribution actually adds a political economy argument for delegation: future generations are generally not sufficiently represented by elected policymakers. Additional distributional aspects of the fiscal balance concern its financing and the implications for expenditure composition of rapid adjustment. However, these distributional repercussions are not necessarily greater than those associated with monetary policy changes.

5

Constraints on the availability of human capital as well as other administrative limitations could nonetheless be a problem in many developing countries.

6

However, similar bodies have been instituted in a number of countries under exceptional circumstances in the absence of adequately functioning domestic political institutions by the international community, not the national government; examples are Austria after World War I or, more recently, conflict areas administered by the United Nations.

7

A range of other potential IFAs discussed in the literature are summarized in Appendix 1.

8

While the well-known technical constraints on the assessment of cyclically adjusted balances would remain, the IFA could at least remove any politically motivated interpretation of underlying economic developments.

9

Some proposals suggest addressing such concerns through accountability-enhancing measures similar to those applied to independent central banks, and/or overriding rules if a qualified majority in parliament disagrees with a decision of the fiscal authority.

11

For example, Committee on Stabilization Policy (2002).

12

Inman (1996) makes a similar proposal.

13

Jonung and Larch (2004), Ubide (2004), and Wyplosz (2005). In this vein, the IMF Code of Good Practices on Fiscal Transparency (see IMF, 2001) recommends independent expert assessments of fiscal and macroeconomic projections.

14

Of course, the format of an FC would need to take country circumstances, including the scarcity of the relevant expertise, into account.

15

It has been argued that a higher degree of separation of powers tends to reduce the size of deficits (Aghion, Alesina, and Trebbi, 2002; and Persson and Tabellini, 2003 and 2004), while a lower degree of internal unity in the government (typically under plurality electoral rules) tends to increase it (Balassone and Giordano, 2001; Fiorina, 1996; and Persson, 2004). These arguments are typically based, among others, on a government’s degree of accountability, its susceptibility to rent-seeking, or the resistance to reform.

16

The social consensus could, however, itself be shaped to some degree by increased transparency that could be provided by a fiscal council.

17

Website: docufin.fgov.be/websedsdd/intersalgen/hrfcsf/onzedienst/Onzedienst.htm. Belgium also has a second FC-type institution, the Federal Planning Bureau (FPB). While technically part of the government, it has some independent standing. The FPB provides independent economic forecasts that must be used for official purposes, long-term forecasts, and policy analysis.

19

In addition to the more independent institutional arrangements in Canada and Chile, which are elaborated here, in some countries forecasts are provided by bodies separate from the government as such, but still under its scrutiny in a wider sense. Examples of such arrangements include Austria (Austrian Institute for Economic Research) and the Netherlands (Central Planning Bureau).

20

Hallerberg, Strauch, and von Hagen (2001); Jonung and Larch (2004); Mühleisen and others (2005); and Strauch, Hallerberg, and von Hagen (2004) find evidence—albeit mixed—for biased budget forecasts in a number of OECD countries. In the same vein, a large proportion of governments have tended to overestimate crucial budget parameters in the past (Table 6.2), according to governments’ own self-assessments.

22

In addition, the Council of Economic Experts (see www.sachverstaendigenrat-witschaft.de) advises the government and parliament on economic policy, but does not make specific recommendations and does not analyze the budget in a comprehensive manner. The government is required to respond formally to the annual report.

23

Also called “Netherlands Bureau of Economic Policy Analysis” (website: www.cpb.nl/eng).