Abstract
This Selected Issues paper analyzes fiscal multipliers in Mexico. Estimates of fiscal multipliers--obtained from state-level spending--fall within 0.6-0.7 after accounting for dynamic effects. However, the size of multipliers varies with the output gap. The planned fiscal consolidation-under the estimated multipliers-is projected to subtract on average 0.5 percentage points from growth over 2015-20. However, there are offsetting effects. The positive growth impulse of lower costs on manufactured goods production is estimated to reach 0.5 percentage point in 2015 and 2016, largely offsetting the impact of fiscal consolidation on growth in the near term.
Strengthening Mexico’s Fiscal Framework1
Mexico’s fiscal framework has improved significantly in recent years, but some shortcomings remain. This chapter argues that the addition of a nominal anchor, limiting discretion under exceptional circumstances, and a fiscal council can enhance the framework’s role as commitment device to fiscal discipline and reduce medium-term fiscal policy uncertainty, particularly after a large negative shock. A new nominal anchor can take the form of an explicit permanent ceiling on the public sector borrowing requirements (PSBR). Setting such ceiling at most at 2.5 percent of GDP would ensure that public debt remains at prudent levels with high probability. Limiting discretion under the exceptional circumstances clause can be achieved by tightening the triggers to invoke it, capping the allowed deterioration in the PSBR, and adding explicit rules about how to return fiscal policy to equilibrium once the clause is invoked. Introducing a fiscal council could help maintain fiscal discipline by providing a non-partisan evaluation of fiscal policy and raising public awareness of the importance of a sound fiscal position.
A. Introduction
1. Macroeconomic management in Mexico has improved significantly since the nineties, allowing Mexico to confront the global financial crisis in 2009 with strong fiscal buffers. Unsound banking practices combined with external imbalances, and public debt heavily skewed towards short-term maturities and foreign-currency denomination culminated in the mid-90’s with the Tequila crisis. Since then much has changed. On the fiscal front in particular, the years before the global financial crisis were characterized by declining public deficits, prudent public debt levels and composition—largely long-term and domestic-currency denominated—and a new fiscal framework aiming at locking in these gains.
2. These fiscal buffers allowed Mexico to act counter-cyclically in 2009, but the crisis left a legacy of high public deficits. The crisis hit Mexico hard, but Mexico’s strong fiscal buffers allowed the country to inject a fiscal stimulus to mitigate the real effects of the shock. However, persistently high fiscal deficits since the crisis suggest that the fiscal framework was effective in allowing flexibility to respond to the global shock but it did not ensure a gradual but steady return to low fiscal deficits in the aftermath of the crisis.
Overall Public Sector Deficit
(In percent of GDP)
Citation: IMF Staff Country Reports 2015, 314; 10.5089/9781513593432.002.A005
Sources: IMF World Economic Outlook; National authorities; and IMF staff calculations.Notes: LA-6 excluding Mexico is comprised of Brazil, Chile, Colombia, Peru, and Uruguay. EM comparator group is comprised of India, Indonesia, Poland, Russia, Thailand, and Turkey.B. Mexico’s Fiscal Framework: Recent Improvements and Pending Tasks
3. Important aspects of the fiscal framework have improved in recent years, including the addition of new fiscal targets and the creation of a sovereign wealth Fund. The fiscal responsibility law, enacted in 2006, aimed at locking in the low fiscal deficits that characterized fiscal performance prior to the crisis. It did so by introducing a zero-balance target on the traditional measure of the deficit. However, the traditional fiscal balance did not reflect properly public debt dynamics (Box 1). As a result, the 2014 amendments to the fiscal responsibility law added the PSBR as a target, a much more comprehensive measure of the public deficit, and introduced a cap on the real growth of current structural spending to limit procyclicality in a framework with a headline deficit target. In addition, the amendments changed the way oil revenues are managed. Starting in 2015, a new sovereign wealth fund, the Mexican Oil Fund, manages all hydrocarbon-related wealth, which should help better insulate public spending from transitory fluctuations in oil revenues.
The Fiscal Responsibility Law: Main Features
The 2006 fiscal responsibility law (FRL) aimed at locking in low deficits and providing a framework for smoothing the spending of oil revenues over the commodity cycle. Over 2004-2006, Mexico maintained fiscal deficits—measured by the traditional balance—close to zero. The FRL aimed at locking in this performance by introducing a zero-balance target on the traditional fiscal deficit measure. It also introduced a reference oil price to be used for revenue projections to smooth the impact of short-term fluctuations in oil prices in the budget. Excess oil revenues were to be used in part to compensate for certain budgetary overruns (e.g., higher interest costs, and the higher fuel bill of the state electricity company) and in part saved into several stabilization funds (to be used in case of shortfalls), but only up to certain limits.
The framework also increased accountability and transparency of fiscal policy. The law called for annual budgets to be presented in the context of a long-term quantitative framework, with projections for the next five years, and mandated an assessment of the fiscal costs associated with new legal initiatives. Other provisions to strengthen expenditure management included greater transparency and controls over the use of trust funds, greater accountability in the selection of investment projects and social programs through cost-benefit analyses, and steps toward performance-based budgeting, requiring the establishment of indicators to measure program outcomes.
The original target, however, had shortcomings. It was too narrow to conduct an appropriate assessment of the fiscal stance and to reflect properly public debt dynamics. Moreover, the target was later relaxed to exclude PEMEX capital investment and more recently to exclude also investment by the state-owned electricity company, CFE, and some strategic projects.
The fiscal framework did not insulate fully public spending from temporary oil-price fluctuations. In principle, the intention of the framework was to save temporary oil windfalls and smooth policy over the oil price cycle. In practice, only a small fraction of the oil revenue windfall was saved (IMF 2013).
The 2014 amendments added new fiscal targets. They include the PSBR, a more comprehensive measure of the fiscal deficit and thus more relevant for debt dynamics, and a cap on the real rate of growth of structural current spending, set initially at 2 percent and equal to potential output growth from 2017 on. The amendments also introduced targets for PEMEX and CFE, consistent with their new legal status.
A Mexican Oil Fund was also created to manage hydrocarbons-related revenues. The fund now manages all oil-related revenues and payments (except for taxes). The Federal Government no longer receives oil-revenues directly from PEMEX, except for income taxes, also applicable to private oil companies, and instead receives transfers from the Mexican Oil Fund for up to 4.7 percent of GDP. Once long-term savings in the Mexican Oil Fund reach 3 percent of GDP, part of the additional inflows will be spent. The previous budgetary revenue stabilization fund (FEIP) and the states revenue stabilization fund (FEIEF) will continue to operate and will be the first line of defense in case of temporary and unexpected declines in revenues. Long-term savings in the Mexican Oil Fund can be used to cover temporary, but persistent declines in revenues only after the FEIP and FEIEF have been exhausted.
4. But the framework still needs an adequate nominal anchor while limited discretion under exceptional circumstances could reduce fiscal policy uncertainty in the aftermath of a large shock. One shortcoming is rooted in how much discretion the framework allows once a shock hits, through the exceptional circumstances clause, both in terms of when and how much the fiscal stance can deteriorate and how it should be brought back to equilibrium. Once in equilibrium, a nominal anchor guiding fiscal policy in normal times would help strengthen the role of the framework as a commitment device to fiscal discipline. In the original framework, the permanent zero-balance target on the traditional measure of the deficit meant to serve as a nominal anchor. However, its effectiveness was eroded by revisions to its definition and the narrowness of its scope.
C. Dealing with Exceptional Circumstances
5. The case for countercyclical fiscal policy is stronger when large shocks—like the global financial crisis—hit the economy. Art. 17 of the FRL allows for ex ante deviations from the traditional balance target under exceptional circumstances. But ideally, only large shocks should trigger the exceptional circumstances clause. The main rationale is that only in those circumstances one can be certain that a large negative output gap has opened up. Countercyclical fiscal policy can therefore help, provided there is policy space. Under small shocks, the need for counter cyclical fiscal policy is weaker due to the inherent uncertainty surrounding estimates of potential output and downward rigidities in spending, which may make it difficult to reverse increases in expenditure.
6. Tighter triggers to allow invoking the exceptional circumstances clause would ensure fiscal policy discretion is only used when it is strictly necessary. The FRL’s regulation includes specific triggers for the exceptional circumstances clause. However, some of these triggers can be reached even under mild shocks.2 The triggers could be adjusted so that the clause is triggered, for instance, only after a 1–2 standard-deviation temporary shock. In some countries, there are no numerical triggers, but invoking exceptional circumstances is constrained by requiring approval by a supermajority in Congress (Switzerland) or severe economic downturns (European Union’s fiscal compact).
7. Once exceptional circumstances are justified, the fiscal framework would also benefit from tighter rules on guiding the return of fiscal policy to equilibrium. This could include limiting the fiscal deterioration allowed in the case of a large shock. For example, in Panama and Peru, the exceptional circumstances clause allows relaxing the deficit ceiling temporarily from 1 percent of GDP up to 3 percent of GDP and 2.5 percent of GDP, in each respective country (Budina and others, 2012). Complementing the framework also with well-specified rules of how to return to equilibrium would ensure a gradual but steady reduction in the PSBR in the aftermath of a large shock. There are several options to achieve this goal. In the case of Peru, the fiscal framework requires an improvement of at least 0.5 percent of GDP per year until the deficit falls below the 1 percent target. Germany and Switzerland have so called “debt brakes,” which involve recording deviations from the deficit ceiling in a notional account until the cumulative balance crosses a predetermined threshold. When this threshold is crossed, the balance needs to be brought down to zero within three annual budgets (Switzerland) or when the economy is recovering (Germany).3
D. A New Nominal Anchor
8. Outside exceptional times, a permanent ceiling on the PSBR could serve as a natural new nominal anchor. Current legislation does not specify a particular ceiling for the PSBR but instead requires that a target for the current year and the medium-term is specified in the budget documents. Current medium-term fiscal targets include reducing the PSBR to 2.5 percent of GDP by 2018 and maintaining it at that level at least until 2021 (the last year of the current projection).
9. The implication of alternative ceilings on the PSBR on the probability distribution of public debt is explored through stochastic simulations. Lacking consensus in the literature on a debt threshold beyond which growth prospects are hurt (IMF, 2012), current debt levels are used as benchmark. Mexico’s public debt-to-GDP ratio is projected to rise slightly above 50 percent but under the baseline scenario, public debt would fall back to 50 percent by 2020. This level of public debt is also within the range of debt ceilings introduced by several countries into legislation (Box 2). The simulations also assume that the PSBR ceiling can be relaxed up to 2 percentage points of GDP—when real GDP growth is one standard deviation below the mean—but it is brought down to below the ceiling within 3 years. These assumptions help derive implications for public debt not only from imposing a permanent ceiling as proposed but also from limiting the use of the exceptional circumstances clause.
10. A permanent ceiling of 2.5 percent of GDP would keep public debt below 50 percent with high probability in the baseline scenario. 4 The simulations are initialized in 2018. Two scenarios are considered, a baseline scenario in which potential GDP growth stays at 3.3 percent over the long term—corresponding to staff’s medium-term potential growth projections—and one in which it is only 2.5 percent, roughly the average growth over the last two decades. Under the baseline scenario, a ceiling of 2.5 percent of GDP would keep public debt below 50 percent with 82 percent probability over the next 25 years. Setting the ceiling at 2 percent or 1.5 percent of GDP would increase this probability to 95 percent and 97 percent respectively. These probabilities correspond to the whole path of the public debt-to-GDP ratio remaining below 50 percent of GDP. The median debt path shows an average debt level—after 25 years—of about 44 percent of GDP, 39 percent of GDP, and 32 percent of GDP, depending on whether the PSBR ceiling is set at 2.5, 2, or 1.5 percent of GDP, respectively.
Examples of Fiscal Rules with Explicit Debt Ceilings
European Union: In 2012, 25 members of the European Council signed the Fiscal Compact agreeing to adopt in legislation national rules that limit annual structural deficits to a maximum of 0.5 percent of GDP and a commitment to continuously reduce the public-debt-to GDP ratio to the 60 percent of GDP threshold, among other elements.
Panama: The Fiscal social Responsibility Law limits the deficit of the nonfinancial public sector at 1 percent of GDP and a debt ceiling of 40 percent of GDP to be reached by 2017.
Indonesia: The State Finance Law and Government Regulation limits the consolidated national and local government budget deficit to 3 percent of GDP and public debt to 60 percent of GDP.
Hungary: The Constitution establishes a debt limit of 50 percent of GDP and public debt must be reduced until this debt ceiling is achieved except when real GDP contracts.
Preemptive Action Triggers
Debt thresholds trigger actions before the debt reaches the ceiling to minimize the risk of breaching it. Examples include Poland and Slovakia, both with debt rules setting a debt ceiling of 60 percent of GDP. In Slovakia, when debt reaches 50 percent of GDP, the Minister of Finance is required to explain to parliament and suggest corrective measures. At 53 percent of GDP, a package of measures is to be passed and wages are frozen. At 55 percent, automatic expenditure cuts for 3 percent and an expenditure freeze for the subsequent year come into effect. At 57 percent of GDP, a balanced budget is required.
11. Under pessimistic potential growth assumptions, only a ceiling of at most 2 percent of GDP would ensure public debt remains below 50 percent with high probability. Under the low potential growth scenario, a PSBR ceiling of 2.5 percent of GDP would imply a 60 percent probability of public debt remaining below 50 percent of GDP over the 25-year simulation period. However, a ceiling of 2 percent or tighter would keep public debt below 50 percent of GDP with 90 percent probability or higher. For this low growth scenario, the median debt path shows an average debt level—after 25 years—of about 48 percent of GDP, 42 percent of GDP, and 36 percent of GDP, depending on whether the PSBR ceiling is set at 2.5, 2, or 1.5 percent of GDP, respectively.
Probability Distribution of Public Debt Under Different PSBR Ceilings
Citation: IMF Staff Country Reports 2015, 314; 10.5089/9781513593432.002.A005
Sources: National authorities; and IMF staff calculations.Note: CDF= Cumulative Distribution Function. The simulation is implemented by first estimating empirical models on real GDP growth and fiscal revenues, which are used to simulate 500 paths of 25 years each. The key underlying assumptions include constant public expenditure in percent of GDP, and annual percent change of GDP deflator equal to 3 percent. The use of exceptional circumstances clause is embedded by relaxing the ceiling in 2 percentage points when real GDP growth is 1 standard deviation below the mean, but it is required to bring it back to below the permanent ceiling within three years. The plots show the unconditional distribution of public debt and the median public debt path across all 500 simulations.E. Fiscal Council
12. The introduction of a non-partisan fiscal council can help making the proposed modifications to the fiscal framework more effective.5 There is a growing interest worldwide in strengthening institutional frameworks through empowering independent watchdogs (Hagemann, 2011; OECD, 2013; IMF, 2013). Fiscal councils contribute to the policy debate by disseminating analyses, opinions, recommendations, and forecasts. Once they have an established reputation, fiscal councils’ opinions and recommendations can help improve fiscal performance. The general idea is that enhanced transparency improves democratic accountability; raises public awareness about the consequences of unsound policy actions; and increases the reputational and electoral costs of reneging on fiscal commitments.
13. There is empirical evidence suggesting that fiscal councils contribute to improved fiscal performance. Evidence from country-specific case studies (Belgium, Chile, Hungary, and United Kingdom) looking at fiscal performance before and after the establishment of a fiscal council suggests that fiscal councils contributed to improve fiscal performance (Hagemann, 2011; Lebrun, 2006; Coene, 2010). Cross-country evidence based on EU countries survey data also suggests fiscal councils can improve fiscal performance in particular when a numerical fiscal rule is in place (Debrun and Kumar, 2007). However, Debrun and Kinda (2014), using an econometric approach in a sample of 58 advanced and emerging markets over 1990–2011, find that the mere existence of fiscal councils is not by itself conducive to stronger fiscal balances. It depends on the characteristics of fiscal councils. Those fiscal councils with either legal independence, adequate human resources, or in charge of monitoring adherence to a numerical fiscal rule, assessment and/or production of forecasts, costing government measures, and those with high media impact are often associated with better fiscal outcomes. Debrun and Kinda (2014) also find that fiscal councils and their key characteristics are associated with lower forecast errors on projections of fiscal outcomes.
14. A non-partisan fiscal council with an explicit mandate to assess the sustainability of public finances could help enforce the proposed modifications to the fiscal framework. The mandate of the fiscal council can be gradually broadened as the council establishes its reputation as a non-partisan and unbiased institution (Box 3 provides examples of mandates). The council could issue assessments and recommendations on the appropriate fiscal policy stance, on compliance with the fiscal framework, and on the sustainability of public finances more broadly. Even if the recommendations are not binding, they could force the fiscal authority to follow a comply-or-explain approach. It could even provide inputs directly into the budget process, for instance by being in charge of macroeconomic and fiscal revenue projections or calculating potential output.
Examples of Fiscal Council Mandates1
Some fiscal councils prepare budgetary forecasts ranging from projections that are mandatorily used in the budget process to just a technical review of the budget assumptions. For instance, the Dutch government uses the macroeconomic, revenue, and expenditure forecasts prepared by the fiscal council. In the United Kingdom, the Office of Budget Responsibility (OBR) produces 5-year economic and fiscal forecasts, with the Treasury subject to a “comply or explain” clause. In the United States, Canada, and Denmark, the fiscal council’s forecasts only serve as a comparator to official projections. In some countries (Colombia and Chile), the fiscal council is responsible to verify the calculation of potential output or the estimation of the reference price of commodities such as oil and copper.
A number of councils produce also medium- to long-term fiscal projections. The US Congressional Budget Office forecasts typically cover a 10 year period, while the British, Canadian, Korean, and Dutch councils produce longer-term projections (over 40- to 75-year horizons) often in the context of a specific mandate to analyze the sustainability of public finances.
Councils also conduct cost analyses of policy measures. These range from simple reviews of tax and spending estimates used in the budget to an extensive costing of specific policy initiatives. The latter approach is often seen in countries where the fiscal council is associated with the legislative branch (e.g. Canada, Korea, and the United States). The Dutch fiscal council routinely responds to requests from line ministries regarding new policy initiatives and provides cost-benefit analysis of major infrastructure projects. In the United Kingdom, the OBR must review the tax and spending estimates produced by government ministries as part of the draft budget proposal, but it does not cost specific policy initiatives. In Australia and the Netherlands, assessments extend also to the economic and budgetary impact of political platforms prior to elections.
Councils can carry out other functions including the analysis of efficiency of public expenditure and fostering coordination among the various entities of the general government. In Korea and Slovenia, the council makes recommendations for improving the efficiency and effectiveness of government programs (existing or planned). Several councils have also an explicit mandate to examine fiscal issues related to state and local governments and/or public enterprises (e.g. Portugal and Austria).
1 Further details can be found in IMF (2013).F. Conclusions
15. The global financial crisis and its aftermath uncovered strengths and weaknesses in Mexico’s fiscal framework. The fiscal framework was effective in allowing flexibility to respond to the crisis and allowed Mexico to act countercyclically in response to the shock. However, it was not very effective in ensuring a gradual but steady return to low fiscal deficits.
16. Going forward, a new nominal anchor, limited discretion under exceptional circumstances, and a fiscal council, can make the fiscal framework more effective. A new nominal anchor, such as an explicit permanent ceiling on the PSBR, could help enhance the fiscal framework’s role as a commitment device to fiscal discipline. Limiting the use of the exceptional circumstances clause to only large shocks; and limiting discretion under exceptional circumstances—by capping the allowed deterioration in the PSBR and specifying explicitly in the framework the adjustment path towards equilibrium—would also reduce fiscal policy uncertainty in the aftermath of a large shock. Furthermore, a fiscal council could help enforce the proposed modifications to the framework and strengthen fiscal discipline by providing assessments and recommendations on fiscal policy.
References
Budina, Nina; Tidiane Kinda; Andrea Schaechter; and Anke Weber, 2012, “Fiscal Rules at a Glance: Country Details from a New Dataset,” IMF Working Paper No. 12/273.
Coene, Luc, 2010. “Lessons from Belgium”, Paper presented at the Conference on Independent Fiscal Institutions, Budapest, 18–19 March.
Debrun, Xavier and Tidiane Kinda, 2014. “Strengthening Post-Crisis Fiscal Credibility: Fiscal Councils on the Rise—A New Dataset.” International Monetary Fund working paper No. 14/58.
Debrun, Xavier and Manmohan S. Kumar, 2007, “Fiscal Rules, Fiscal Councils and All That: Commitment Devices, Signaling Tools or Smokescreens?” in: Banca d’Italia (eds.) Fiscal Policy: Current Issues and Challenges, Papers presented at the Banca d’Italia workshop held in Perugia, 29–31 March 2007, pp. 479–512.
Hagemann, Robert, 2011, “How Can Fiscal Councils Strengthen Fiscal Performance?” OECD Journal: Economic Studies, Vol. 2011/1.
International Monetary Fund, 2005. “Promoting Fiscal Discipline: Is There a Role for Fiscal Agencies?” IMF Policy Paper, (Washington, DC: International Monetary Fund).
International Monetary Fund, 2012, “The Good, the Bad, and the Ugly: 100 Years of Dealing with Public Debt Overhangs,” World Economic Outlook, October 2012, chapter 3.
International Monetary Fund, 2013a. “Mexico—Reforms to the Fiscal Framework.” Mexico: Selected Issues, International Monetary Fund country report No. 13/333.
International Monetary Fund, 2013b. “The Functions and Impact of Fiscal Councils.” IMF Policy paper, (Washington, DC: International Monetary Fund).
Lebrun, Igor, 2006. “Fiscal Councils, Independent Forecasts, and the Budgetary Process: Lessons from the Belgian Case.” In Ayuso-i-Casals and others, Policy Instruments for Sound Fiscal Policy, Palgrave-MacMillan.
Organization for Economic Cooperation and Development, 2013, “OECD Principles for Independent Fiscal Institutions,” Public Governance and Territorial Development Directorate, May.
Prepared by Fabian Valencia. The author thanks Carlos Caceres, Dora Iakova, Alex Klemm, Luis Madrazo, Robert Rennhack, and seminar participants at the Bank of Mexico and the Ministry of Finance for valuable comments and suggestions and Alexander Herman for outstanding research assistance.
Examples of triggers include a decline in tax revenues for 2.5 percent in real terms and a 10-percent decline in oil prices, both representing only slightly less than half a standard deviation shock (computed on the annual changes in both variables over 1996-2014).
In Germany, only those deviations that did not result from errors in real GDP growth projections enter the notional account, whereas in Switzerland all misses count.
Public expenditures are assumed to remain constant as a fraction of GDP at 2018 levels, except when the deficit ceiling binds, in which case expenditures are adjusted as needed to meet the PSBR ceiling. The GDP deflator is assumed to grow 3 percent per year, the permanent inflation target of the Bank of Mexico. Fiscal revenues and real GDP growth are treated as stochastic variables. To this end, a linear regression model is estimated relating fiscal revenues growth in real terms to its lagged value and real GDP growth. Similarly, an ARMA (1, 1) model is estimated with real GDP growth data where the constant term is adjusted so that the unconditional mean of real GDP growth equals 3.3 percent under the baseline scenario or 2.5 percent under the low growth scenario. Random draws are obtained from the empirical distribution of the error term in both empirical models to construct 500 paths of 25 years each for the stochastic variables.
Fiscal councils, broadly defined, refer to an independent public institution informing the public fiscal debate without partisan influence. More specific definitions narrow down the functions of a fiscal council to comply with this overarching objective and elaborate on what independence means. IMF (2005, p. 4) suggests that a council’s main functions could include the provision of independent analysis on fiscal policy developments, the preparation of unbiased projections, and the issuance of “normative judgments” (recommendations) on fiscal policy. OECD (2013) clarifies that the notion of “independence” relates to the non-partisan nature of the council’s analysis, and that the work of the council should be forward-looking in essence.
