APPENDIX—Algebra for the alternative ECM rule
Formally, the multi-year ECM could be defined as follows. Taking a given year x + 1 as the starting point of a planning period of s years, the government should set (at the end of period x) nominal expenditure ceilings for each year between x + 1 and x + s.3 These ceilings should be consistent with a certain debt objective for the period. If actual debt in year x is below the normative path
One specific functional form for the required debt reduction over the period [x +1, x + s] could be written as:
The expenditure ceilings can be defined in nominal terms:
In normal circumstances, expenditure ceilings are set for s years, to preserve automatic stabilizers on the revenue side. However, expenditure rules require a certain flexibility (see above). First, excessive deviations from the debt norm should be avoided (e.g. because of tax cuts, stock-flow adjustments, or large forecast errors in average interest rate and GDP growth).4 Hence, if in any year
Prepared by Xavier Debrun (FAD) and Natan Epstein (EUR).
The recognition that large increases in public spending—associated with the substantial wave of immigration from the former Soviet Union during the early 1990’s—would result in a deterioration of the fiscal position, prompted the adoption of the Deficit Reduction Law in 1991. The law was intended to send a signal to the markets that the rise in the deficit was transitory (Flug, 2006).
See Kopits and Symansky (1998) for detailed discussion on fiscal policy rules, including their key characteristics. They define a good rule as being simple, transparent, coherent with the final goal, but mindful of other goals of public policies.
Enforcement translates deviations from targets into some subjective cost (“disutility”) for the decision-maker.
The sub-national governments (Cantons) are not integrated, nor coordinated with the federal government, but generally have balanced budget rules in place already (Lundback, 2008).
The mechanism was supposed to govern central government budgets starting from 2003. In practice, however—due to a large structural deficit during an unexpected recession that year—it began to take effect with the 2004 budget (Bodmer 2006).
In fact, the fictional account generated a total credit of around 1.3 percent of GDP between 2004–06, which was largely due to an increase in the expenditure ceiling each year that subsequently were under-executed.
The difference between the central government balance (cash basis) and the general government balance (accrual basis) comprises the deficits of the local governments (averaging about zero percent of GDP over the past five years) and interest accrued on inflation-index-linked government debt. The latter can vary widely as a function of inflation but has averaged around 1 percent of GDP over the past five years.
NII expenditure and revenue (vis-à-vis the public) amount to about NIS 45 billion and NIS 25 billion, respectively. To close the gap, the government transfers to NII, on a net basis, some NIS 20 billion. This allows the government to circumvent the expenditure growth ceiling, for example, by increasing its transfers to NII without reflecting the corresponding increase in spending in the budget. A similar loophole exists with respect to the collection and outlays of health related taxes.
While, for operational reasons, the central government balance constitutes the appropriate variable to target, all further scenario analysis and simulations are based on the corresponding general government balance, since it is more closely associated with changes in the overall public debt.
Sensitivity analysis suggests the results are robust to (small) changes in the parameters values.
The potential growth series is updated using a moving average of real GDP growth on a rolling eight-year basis. An alternative measure of potential growth using an HP filter shows very similar results.
Another conceptual issue is that the debt brake leads to a debt-to-GDP ratio that is asymptotically zero. This is the reason why, in the version proposed in the previous section, the rule would be revisited once public debt has been reduced to 60 percent of GDP.
In both cases, and to speed up debt reduction, negative deviations from the norm would only trigger an upward correction of the expenditure ceiling when debt is at or below 60 percent.
Of course, another option is to use an estimate of trend (or cyclically-adjusted) revenue levels. That would relax (tighten) expenditure growth ceilings when the output gap is negative (positive). However, this approach amounts to reintroduce the output gap at the center of the picture, which has some drawbacks, as already discussed.
The rule would have to specify the precise events that could trigger an increase in expenditure above the ceiling.
For reasons related to simplicity, transparency and consistency with the ultimate objective, total expenditure should be subject to the ceiling even though some expenditure items are not under the control of the government, including interest payments or investment projects financed by specific external grants.
Unlike the Swiss debt-brake rule, where the ECM is triggered based on deviations from a pre-specified level of deficits accumulation, the alternative ECM rule is anchored more explicitly on a targeted debt path, i.e., the correction mechanism is based directly on deviations from a “norm” debt path objective.
See IMF Country Report (2007)
Parameter s (the length of the planning horizon) reflects the authorities’ choice on the trade-off between flexibility in the response to unforeseen events and the timely realization of the debt objective. A reasonable benchmark could be the length of a normal legislature. It could also be shorter given the potentially large forecast errors at longer horizons. For instance, s = 3 in the Swedish case.
Again, setting a threshold for acceptable deviations is a matter for discussion, but 5 to 10 percent of GDP seems an appropriate range if one wants to avoid significant contractions in bad times.
Bodmer, F., 2006, “The Swiss Debt Brake: How It Works and What Can Go Wrong,” Schweizerische Zeitschrift für Volkwirtschaft und Statistik 3/142 pp. 307–330.
Catalan, Mario, 2007, “Fiscal Institutions and the Political Economy in Israel,” in Israel—Selected Issues, IMF Country Report 07/25 (Washington: International Monetary Fund).
Danninger, Stephan, 2002, “A New Rule: The Swiss Debt Brake,” IMF Working Paper 02/18 (Washington: International Monetary Fund).
Debrun, Xavier, Laurent Moulin, Alessandro Turrini, Joaquim Ayuso-i-Casals, and Manmohan S. Kumar, 2008, “Tied to the Mast? The Role of National Fiscal Rules in the European Union,” Economic Policy, forthcoming.
Elekdag, Selim, Natan Epstein, and Marialuz Moreno-Badia, 2006. “Fiscal Consolidation in Israel: A Global Fiscal Model Perspective,” IMF Working Paper 06/253 (Washington: International Monetary Fund).
Flug, Karnit, 2006, “The Bumpy Road Towards Fiscal Consolidation: What is the Role of Fiscal Rules, Fiscal Policy in Israel since the 1990’s,” paper presented at the Euro-Mediterranean Conference, ECB, and Falk Institute Annual Conference.
Kopits George and Steven Symansky, 1998, “Fiscal Policy Rules,” IMF Occasional paper No. 162. (Washington: International Monetary Fund).
Lundback, Erik J, 2008, “Medium-Term Budgetary Frameworks—What Can Austria Learn from Other Countries?” IMF Working Paper 08/xx (Washington: International Monetary Fund), forthcoming.