The note delves on the U.S. housing market outlook, the potential benefits of mitigating distressed sales household deleveraging, and the recovery. Policies to facilitate labor market adjustment to reduce the large employment volatility without affecting efficient labor allocation could prevent problems. U.S. firms are hoarding money but it is likely to be spent to boost firms’ capital expenditure, rather than kept as precautionary balances. The note discusses commodity price shocks affecting Treasury inflation protected securities (TIPS), budget institutions for federal fiscal consolidation, and mortgage delinquencies in the United States.

Abstract

The note delves on the U.S. housing market outlook, the potential benefits of mitigating distressed sales household deleveraging, and the recovery. Policies to facilitate labor market adjustment to reduce the large employment volatility without affecting efficient labor allocation could prevent problems. U.S. firms are hoarding money but it is likely to be spent to boost firms’ capital expenditure, rather than kept as precautionary balances. The note discusses commodity price shocks affecting Treasury inflation protected securities (TIPS), budget institutions for federal fiscal consolidation, and mortgage delinquencies in the United States.

VIII. Budget Institutions for Federal Fiscal Consolidation1

Fiscal consolidation efforts will need to be sustained over many years and could therefore be supported by targeted reforms of budgetary institutions. Endorsement of clear medium-term objectives by Congress would anchor expectations, multi-year expenditure caps for non-security discretionary spending would help keep consolidation on track across the annual budget cycles, and a carefully designed failsafe mechanism could help protect against deficit overruns. Using a realistic macroeconomic framework is essential.

1. The U.S. faces a large multi-year fiscal adjustment which could be helpfully supported by reforms of budgetary institutions. In some relevant areas, the quality of federal budgetary institutions is excellent. For example, fiscal reporting and forecasting are comprehensive, timely, and of outstanding quality; the available background analysis provides policymakers with ample information on the long-run fiscal challenges and policy options; and there are firm controls in the budget execution:

  • Budget forecast. The Office of Management and Budget (OMB) and the nonpartisan Congressional Budget Office (CBO) prepare 10- and 75-year budget projections under alternative scenarios. Risks are generally well disclosed, including through dedicated reports on the cost of financial bailouts (TARP) and risks from the conservatorship of Fannie Mae and Freddie Mac.

  • Policy analysis. The CBO and the Joint Committee on Taxation (JCT) estimate budgetary implications of all major policy proposals, with the OMB and Treasury preparing such estimates for internal use within the administration. The OMB (based on inputs from the Office of Tax Analysis in Treasury) and JCT regularly publish comprehensive reports on tax expenditures, including five-year projections of foregone revenues. The CBO also publishes detailed analyses of policy options for deficit reduction. The Government Accountability Office (GAO), an independent nonpartisan agency, assesses how government programs meet their objectives.

  • Budget execution. There are strong restrictions on overspending during budget execution. OMB apportions spending into allotments by time period, project, or activity and there are strong penalties for exceeding allotments. There are also restrictions on carrying over appropriations.

2. However, some existing federal budgetary processes are not well suited for dealing with the current key policy issues. These require a sustained effort spanning many years—stabilizing medium-term public finances while addressing the longer-term pressures from population aging and rising health care costs. The weaknesses include:

  • Lack of a medium-term framework in Congress. While the administration has committed to meeting the Toronto G-20 deficit and debt targets, and the President has proposed a new framework for putting the federal debt ratio on a downward path in the medium term, Congress has had no fiscal anchor since the Budget Enforcement Act expired in 2002.2 Neither the OMB’s 10-year projections for federal outlays, nor projections in the Congressional budget resolution provide binding multi-year restrictions on total spending. The statutory pay-as-you-go (PAYGO) rules for revenue and mandatory spending reinstated last year are subject to several important exemptions.3

  • Long and unpredictable annual budget cycle. The cycle focuses on discretionary spending appropriations—a small portion of total outlays ($1.2 trillion compared with $3.7 trillion). Underfunded mandatory spending programs such as Medicare or Social Security are not included in the annual budgetary process, pushing difficult choices into the future. Meanwhile, reflecting the constitutional arrangements, the Congress is free to adopt appropriations bills that differ considerably from the President’s proposals, loosening the link between administration’s policy intentions and outcomes.4 In case of disagreement over discretionary spending, Congress needs to agree on a short-term continuing resolution, or risk a shut-down of nonessential government functions.

  • Optimistic macroeconomic framework. The administrations’ macroeconomic projections have recently been significantly more optimistic than the Consensus Forecast and CBO forecasts, raising questions about the official estimate of fiscal consolidation needs (Figure 1).5 In particular, policies proposed in the President’s February budget stabilize the debt-to-GDP ratio over the medium-term, but in the CBO and IMF projections, the debt ratio does not stabilize, largely due to more conservative macroeconomic assumptions. While all institutions have over time made sizeable forecast errors and no institution is a much better forecaster than another (Appendix Figure), a fiscal consolidation strategy should not be built on a set of assumptions which are close to the upper end of available projections.

Figure 1.
Figure 1.

Comparison of Long-Term GDP Forecasts

Citation: IMF Staff Country Reports 2011, 202; 10.5089/9781462317356.002.A008

Appendix Figure.
Appendix Figure.

Real Output Forecast Errors

Citation: IMF Staff Country Reports 2011, 202; 10.5089/9781462317356.002.A008

Sources: Congressional Budget Office; Office of Management and Budget; Consensus Economics; Haver Analytics; and Fund staff estimates.

3. These considerations have been reflected in the ongoing discussions about the U.S. consolidation strategy. Policymakers intend to establish broad medium-term fiscal objectives accompanied by institutional mechanisms such as spending caps, balanced budget requirements, and “failsafe” rules. The failsafe would trigger automatic spending and/or revenue adjustments should fiscal policy fail to achieve a pre-set target.6 The recent focus on budget institutions has also reflected the high degree of political polarization as documented, for example, by Orszag (2011). Given the difficulty of agreeing on a full set of specific revenue and spending measures, the institutional clauses are seen as a commitment to continued fiscal consolidation, with the threat of broad-based sequesters should the policymakers fail to agree on future steps. It is important to keep in mind, however, that similar institutional protections and triggers have in the past had mixed success, with sequesters often modified or overridden when they became binding—the Gramm-Rudman-Hollings Act and the Medicare Sustainable Growth Rate mechanism are notable examples (Table 1).

Table 1.

United States: Selected Institutional Reforms to Support Fiscal Adjustment.

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Sources: Concord Coalition, 2011; Congressional Budget Office, 2011; Congressional Research Service, 2010; IMF, Fiscal Monitor, April 2011; Mauro et al., 2011; Peterson-Pew Commission on Budget Reform, 2011.

4. The following institutional enhancements could play a useful role in supporting fiscal consolidation, taking as given the strong constitutional role of Congress in formulating budget policy:

  • Clear medium-term objectives. Endorsement of specific medium-term objectives (these could include debt or deficit targets) by both chambers of Congress is essential to anchor expectations and achieve consistency with the administration’s plans.

  • Realistic macro framework. The administration’s macroeconomic framework could explicitly include inputs from the private sector forecasters. Participation by outside participants in the forecasting process is common—notably, Canada has closely adhered to the consensus forecast marked down with an additional prudence factor since embarking on an ambitious consolidation strategy in the 1990s. Australia and Germany also consult widely on their macroeconomic framework. More recently, the United Kingdom created an independent agency to guide the forecasting process (Table 2).

Table 2.

Key Institutional Characteristics of the Fiscal Forecasting Process

article image
Sources: Muhleisen et al. (2005); and updates by IMF desk economists and country authorities.
  • Multiyear expenditure restraint. Multi-year expenditure caps on non-security discretionary spending could help keep consolidation on track across the annual budget cycles. Cross-country evidence suggests that compliance with spending targets improves when the limits are more legally binding. In the United States, constraints on discretionary expenditures during the 1990s facilitated a faster-than-expected improvement in the fiscal balance amid strong growth and asset price boom; France and the United Kingdom also benefited from spending caps (Mauro et al., 2011).

  • Failsafe mechanism. Given the mixed experience with automatic spending rescissions in the past, the mechanism would need to be carefully designed. The failsafe mechanism should be underpinned by clear debt or deficit objectives and applied continuously. The automatic spending cuts and revenue increases (possibly through cuts in tax expenditures) should apply broadly. The implied annual rescissions must not be too big to become implausible as in the case of the Medicare SGR and the GRH Act. Any escape mechanisms should be clearly defined and reserved for truly exceptional circumstances such as a recession or national emergency. To ensure credibility, any forecasts should be prepared under realistic macroeconomic assumptions, possibly with inputs from outside of the administration.

5. It is important to keep in mind that improved budgetary institutions are no substitute for the willingness to purse good policies and public support for tough choices. International experience suggests that public support is crucial for the successful implementation of large fiscal consolidation (IMF, 2011). For example, opinion polls ahead of the mid-1990s consolidation in Canada showed broad public support for debt reduction. The authorities took advantage of this to put in place a communication strategy to reinforce support for their adjustment plan. In the United States, the public recognition of fiscal challenges has grown and the issue of rising public debt has become central to the policy debate. That said, some evidence suggests that the sources of long-term fiscal challenges are still not well understood by the public, with survey participants frequently calling for maintaining entitlement spending, while resisting tax increases.

References

  • The Concord Coalition, 2011, “Process Reform as Deficit Reduction: A First Step, But No Substitute for Policy”. Washington, D.C.

  • Congressional Budget Office, 2011, “Medicare’s Payments to Physicians: The Budgetary Impact of Alternative Policies”. Washington, D.C.

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  • Congressional Research Service, 2010, “Federal Budget Process Reform in 111th Congress”. Washington, D.C.

  • International Monetary Fund, 2011, Fiscal Monitor, April edition. Washington, D.C.

  • Mauro, Paolo, ed., 2011, “Chipping Away at the Public Debt: Sources of Failure and Keys to Success in Fiscal Adjustment” (Wiley, forthcoming).

  • Muhleisen, Martin, Stephan Danninger, David Hauner, Kornelia Krajnyak, and Bennett Sutton, 1995, “How Do Canadian Budget Forecasts Compare With Those of Other Industrial Countries,?” IMF Working Paper 05/66 (Washington, International Monetary Fund)

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  • Orszag, Peter R., 2011, “Health Care, Political Polarization, and Our Fiscal Future”, Presentation at the Peterson Institute for International Economics.

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  • Peterson-Pew Commission on Budget Reform and The Committee for a Responsible Federal Budget, 2011, “Peterson-Pew Fiscal Targets: Ten Issues in Designing a New Debt Failsafe” Washington, D.C.

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1

This chapter was prepared by Martin Sommer. The author would like to thank Andrea Schaechter, Teresa Curristine, and Jiri Jonas for helpful discussions.

2

The Budget Enforcement Act of 1990 (BEA) established statutory caps on discretionary appropriations and a pay-as-you-go mechanism for revenue and mandatory spending. Both rules were later revised, expiring in 2002.

3

The pay-as-you-go (PAYGO) rules stipulate that new deficit-raising policies must be financed by other measures over a specified time period. Certain programs (for example, legislation with an “emergency” designation, Social Security, or the Bush tax cuts for the middle class) were exempt from these rules.

4

Some cross-country research suggests that, even during the pre-crisis period, the United States experienced unusually large deviations of budgetary outcomes relative to the administration’s plans (Muhleisen et al, 2005), which is unlikely to be explained by macroeconomic surprises.

5

As of last November (when the administration prepared its macroeconomic framework), the administration’s 2012 growth forecast of 4 percent (Q4-on-Q4) was in the middle of the Federal Reserve FOMC members’ central tendency. The administration’s 2013 growth projection of 4.5 percent was at the upper bound of the central tendency. Longer-term comparisons are not possible due to limited data availability.

6

See a website by the Committee for a Responsible Federal Budget for a detailed description of alternative fiscal plans, including proposed institutional mechanisms: http://crfb.org/compare/index.php?id=01.

United States: Selected Issues
Author: International Monetary Fund