Policy biases and possible solutions

6. For more than three decades, a vast literature has sought to explain why rational and accountable policymakers would choose undesirable policies. The reasons and nature of these systematic deviations from optimal policies—or policy biases—are multiple, and they apply to many policy instruments: monetary policy (inflationary bias), regulatory policy (too little or too much regulations depending on cases), or structural policy (status quo bias).

7. In the fiscal policy area, excessive deficits leading to rising debt-to-GDP ratios, and a tendency to spend temporary revenue windfalls (procyclicality in good times) are two widespread and well-documented biases. They often reflect failures to coordinate competing claims from various constituencies on the revenue pool (the so-called common pool problem), politicians’ re-election concerns (leading to myopia when re-election is fundamentally uncertain, or opportunistic pre-election spending), or an imperfect understanding of the government’s budget constraint in the population at large (“fiscal illusion”).² The latter problem is particularly relevant in resource-rich countries, where the complexities of assessing commodity cycles and large short-term spending pressures may lead to insufficient savings. As policy biases are invariably rooted in inadequate policymakers’ incentives, the prospective solutions have in common an attempt to get these incentives right.

8. Ways to correct policy biases generally rely on one or a combination of the following approaches:

• Rules. Rules seek to impose a direct and durable constraint on policy choices, imposing limits on variables that are generally close to policy instruments (i.e. under good control of policymakers). Prominent examples include limits on the growth of monetary aggregates in the late 1970s and 1980s, and ceilings on government deficit and debts laid out in EU law, or balanced budget rules in most US states.

• Independent authorities. The delegation of policy instruments to independent agencies is another way to get incentives right. The main characteristics of these arrangements are strict guarantees of independence for the agency, a well-defined mandate against which the agency can be held accountable, and complete discretion for the agency in setting the delegated policy instruments to achieve its goals. Perhaps the best illustration of the delegation approach is the exercise of monetary policy by independent central banks.

• Influence and persuasion. Softer institutional arrangements exist for policies that (i) are not amenable to rules (mainly because they are inherently complex and not easily measurable, such as structural policies), and/or (ii) cannot be delegated outside the political sphere for clear normative reasons (mainly because they are distributive in nature, such as tax and transfer policies). These soft arrangements include the routine surveillance activities of international or supranational institutions as well as the work of watchdog bodies, whose role is to enrich the public policy debate through analysis, information, and advice.

  Fiscal councils belong to the third category. As such, they are fundamentally different from independent central banks, to which they are often, and incorrectly, compared (Debrun, 2011).

Independent Fiscal Authorities vs. Fiscal Councils

9. Fiscal policy rules have generally been the institutional solution of choice to address excessive deficits. Quantitative limits on debts, deficits, or spending have long been used to contain fiscal profligacy (e.g. Fabrizio and Mody, 2006; Debrun and others, 2008; and IMF, 2009). Yet, experience has revealed limitations often related to the rules’ inflexibility in the face of adverse or unusual circumstances, or to the lack of supportive budget procedures. Inflexibility ultimately threatens the credibility of the rule itself, as the pressure of events can quickly lead to its suspension or even elimination.

10. Difficulties with fiscal rules have led some academics to propose the establishment of independent fiscal authorities. Like central banks, these institutions would receive the power to set binding limits to the budget deficit—or public debt accumulation—each year, including the capacity to use certain tax levers during the budget year to ensure compliance if slippages occur.³ The theoretical underpinning of such proposals parallels arguments developed in favor of independent central banks after monetary policy rules had proved impractical in a context of unstable money demand (Thomson, 1981; Rogoff, 1985).

11. However, the case for fiscal policy delegation can be dismissed on both normative and positive grounds, and there is no real-world example of independent fiscal authorities. From a normative angle, all aspects of fiscal policy—including the deficit—are primarily distributive (across individuals, social groups or generations), which precludes delegation to unelected policymakers.⁴ From a positive perspective, fiscal delegation itself is likely to lack credibility. Indeed, the distributive nature of fiscal decisions often makes excessive deficits and debts irresistible (i.e. individually optimal for the policymaker) ex-ante.⁵ As a result, the delegation of fiscal policy to an independent authority is never perceived as desirable by policymakers, which explains why there is no example of such authorities (Debrun, 2011).

12. What is left in the quest for discipline-enhancing fiscal frameworks is an analysis of how influence and persuasion could be organized in the fiscal realm. A small but growing literature has argued that independent fiscal institutions, labeled as “fiscal councils,” could improve policymakers’ incentives to opt for sound fiscal policies even in the absence of delegation. First, by fostering transparency over the political cycle, a fiscal council can improve democratic accountability and discourage opportunistic shifts in fiscal policy (e.g. pre-electoral spending spree). Second, through independent analysis, assessments, and forecasts, such bodies can raise public awareness about the consequences of certain policy paths, contributing to a stability culture that directly addresses fiscal illusion. Hence a fiscal council can raise the reputational and electoral costs of unsound policies and broken commitments. Third and finally, a fiscal council can provide direct inputs to the budget process—e.g. forecasts or assessments of structural positions—thereby closing technical loopholes that allow governments to circumvent numerical fiscal rules.

Remit and Tasks of Fiscal Councils

21. While the common impetus for the creation of fiscal councils has been to encourage sound fiscal policies through independent oversight, there is considerable diversity among them. Beyond the common motivation, the design of individual institutions reflects the legal, political and institutional environments of each country, as well as the specific causes and manifestations of the bias affecting discretionary policies. Fiscal councils can nevertheless be categorized following economically relevant characteristics, including their remit or functions, the tasks performed to accomplish these functions, and basic institutional features, including their governance. The analysis will also make a distinction between “veterans” (established prior to 2005) and the “new generation” (established in 2005 or later). The rationale for that distinction is that the design of new institutions may have been influenced by the intensifying academic debate on their potential role in improving the conduct of fiscal policy¹⁰ , and by the accumulating experience with politically independent agencies in other policy areas such as central banking or the regulation and supervision of specific sectors (banking, energy, media).

22. In line with the definition proposed above, the functions of fiscal councils generally belong to one of the following broad categories (Figure 2):

• a. Independent analysis, review, and monitoring of government’s fiscal policies, plans, and performance. This includes reviews of governments’ annual or medium term budget proposals generally with respect to compliance with official objectives—such as those enshrined in fiscal policy rules—and/or the long-term sustainability of public finances and the related risks. Typically, fiscal councils focus on a macroeconomic analysis anchored in their ultimate objective to promote sound fiscal policies by informing the public debate. Fiscal councils also provide ex-post assessments of macroeconomic and fiscal performance against official aggregate objectives and targets. More broadly, councils also carry out research with clear relevance for the health of public finances and the conduct of fiscal policy, such as labor market performance, the impact of aging population, or the extent of tax expenditures.

• b. Developing or reviewing macroeconomic and/or budgetary projections. Assessments of macroeconomic and/or budgetary forecasts can be associated with a right to publicly denounce eventual biases or an obligation—de jure or de facto—from the government to “comply or explain” in case of significant differences between the forecasts underlying budget plans and those of the council. The council could also be mandated to prepare the macroeconomic forecasts used for budget preparation or to set key assumptions and parameters, such as a prudent price level for certain commodities with a large budgetary impact (either because the country is a large commodity producer or because of extensive subsidy schemes).

• c. Costing of budget and policy proposals, including possibly, election platforms. Beyond macroeconomic and revenue forecasts, a fiscal council could also be tasked to produce unbiased estimates related to specific spending programs or policy measures.

• d. Advising policymakers on policy options. This function can be general—a right to comment and issue recommendations on any policy issue of its choosing—or specific—limited to a particularly contentious issue that must be solved by consensus. A general function is better suited to countries with an already rich public debate and a relatively consensual approach to policy-making. A specific function can be useful in issues such as the sharing of certain revenues across unequal regions, where a consensus must be found but interests among decision makers diverge strongly. In resource-rich economies, issues related to the regional and intergenerational distribution of revenues from non-renewable commodities is also an area where non-partisan inputs could avoid undesirable biases.

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Remit of Fiscal Councils (relative frequencies)

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Source: IMF Fiscal Council Dataset.

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23. While all fiscal councils identified for this study routinely perform broad oversight functions, there is much more variation as regards the other functions described above. For instance, the Netherlands Bureau for Economic Planning Analysis performs extensive forecasting and costing functions. However, it does not make judgments on the appropriateness of the government’s budgetary plans. In contrast, the Swedish Fiscal Policy Council and the Irish Fiscal Advisory Council engage in normative analysis, but do not produce their own forecasts or costing. Some countries have even established a division of labor between different institutions. In Belgium, the Federal Planning Bureau focuses strictly on the provision of macroeconomic forecasts, whereas the High Council of Finance (Public Sector Borrowing Requirement Section) performs oversight and monitoring functions, and must provide policy recommendations, including on the distribution of the eventual fiscal effort among central and subnational entities to comply with general government rules.

24. Recent fiscal councils are more often explicitly tasked to monitor compliance with fiscal policy rules and to cost policy measures. While the vast majority of fiscal councils continue to perform positive analyses, evaluate long-term sustainability issues, and prepare or assess macroeconomic forecasts, newly created ones have broader remits (Figure 2). The majority (more than ¾) of the new generation monitor compliance with fiscal rules, more than the double compared to veteran institutions. This trend is associated with the increasing use of numerical fiscal rules (Schaechter and others, 2012) and is likely to continue given new legal requirements mandating such independent monitoring for most European Union member states (see Box 2 in the Policy Considerations Section). The costing of policy initiatives has also become a more common feature among newer fiscal councils.

25. The approaches taken to perform some of these broad functions vary significantly across countries.

• a. Fiscal councils’ involvement in budgetary forecasts ranges from preparing a set of macroeconomic and revenue projections that the government is obligated to use to a mere technical review of the budget assumptions. For instance, the Dutch government uses the macroeconomic, revenue, and expenditure forecasts prepared by the fiscal council, whereas Belgium’s budget must be based on macroeconomic forecasts from the Federal Planning Bureau. In the United Kingdom, a core mission of the Office of Budget Responsibility (OBR) is to produce 5-year economic and fiscal forecasts, with the Treasury subject to a “comply or explain” clause—i.e. it has to publicly motivate its eventual choice not to use OBR’s forecasts. In the United States, Canada, and Denmark, the fiscal council’s forecasts only serve as a comparator to official projections. Elsewhere, the council’s role in forecasting is limited to ex-ante and/or ex-post reviews of government’s economic and budgetary forecasts, including the underlying assumptions and models used. For instance, the Swedish fiscal council has recently evaluated the quality of government forecasts.

• b. Given the challenges related to entitlement regimes, a number of councils go well beyond yearly forecasts, taking a medium or long term view of fiscal trajectories. For instance, the US Congressional Budget Office forecasts typically cover a 10 year period, while the British, Canadian, Korean and Dutch councils produce long-term projections (over 40 to 75 years horizons) often in the context of a specific mandate to analyze the sustainability of public finances.

• c. Approaches to the costing of policy measures—an activity in which nearly half of fiscal councils are involved—are also highly country-specific. These range from simple reviews of tax and spending estimates used in the budget to an extensive costing of specific policy initiatives emanating from government or individual parliamentarians. The latter approach is often seen in countries where the fiscal council takes the form of a budget office associated with the legislative branch, including Korea, Mexico, and the United States.¹¹ In Canada, the office of the Parliamentary Budget Officer conducts only selected costing of bills and proposals from the legislature and it assesses the government’s own costing of existing programs. Nested in the Ministry of Economic Affairs, 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 go beyond legislative or executive proposals and extend to the economic and budgetary impact of political platforms prior to elections.

26. Fiscal councils can carry out other functions, although they never imply binding constraints on policymakers’ discretion. Among these other functions, one finds analyzing the efficiency and/or effectiveness of public expenditure and fostering coordination among the various entities of the general government. In Korea, the NABO has an important evaluation role and makes recommendations for improving the efficiency and effectiveness of government programs (existing or planned). Providing an annual assessment of the effectiveness of public spending is also part of Fiscal Council’s mandate in Slovenia. Although these activities are limited to the central government,¹² several councils have an explicit mandate to examine fiscal issues related to state and local governments and/or public enterprises. In Portugal, the Council on Public Finances (CPF) is required to assess the financial position of autonomous regions, local governments, and public enterprises, while in Austria the Government Debt Committee analyzes “the effects of financial operations on the national economy in connection with the indebtedness of all the public authorities,” and in Belgium the High Council of Finance makes recommendations on the contribution of each government entity to secure compliance with general government rules.

27. Overall, fiscal councils influence the conduct of fiscal policy mostly indirectly through the public debate, and only rarely through direct action in the budget process. All fiscal councils prepare public reports that often have a significant media impact (Figure 3). This is an essential vehicle for the reputational impact fiscal councils work is expected to have on policymakers. Not surprisingly, the well-established councils are more likely to benefit from a solid reputation of independence and professional competence than younger peers. Direct involvement in the form of providing forecasts that are either binding or linked to a “comply or explain” clause is rare. Interestingly, however, close to one half of post-2005 fiscal councils hold formal consultations with the government or hearings in Parliament on a regular basis, which gives them more direct access to decision makers. Yet no fiscal council has any direct or indirect veto right that could stall the budget process.

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Tasks and Channels of Influence (relative frequencies)

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Source: IMF Fiscal Council Dataset.

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Independence, Accountability and Governance

28. Independence from partisan influence is often enshrined in legal provisions banning political interference, especially among newer councils (Figure 4). A majority of fiscal councils enjoy legal protections against partisanship. These include strict requirements of professional proficiency and expertise for the council’s management and staff,¹³ non-renewable tenures exceeding the normal legislative term, and procedures that reduce the risk of politically-motivated appointments—see Box 3 in the Policy section. Independence also implies the freedom for the council to undertake any analysis it deems necessary to fulfill its mandate and to choose its communication strategy. While a large majority of fiscal councils benefit from such protections, they are noticeably more prevalent among newer institutions, likely reflecting the fact that they have no established record of independence and professional excellence. This may also reflect the evolution of the academic debate emphasizing the need for guarantees comparable to those applied to central banks.

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Aspects of Independence

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Source: IMF Fiscal Council Dataset. Coverage varies with data availability

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29. The operational independence of the fiscal council also requires that resources remain commensurate (in quality and quantity) to its remit at all times. Unlike central banks, a council has no significant own income, and the risk of politically-motivated changes in their resource envelope should be minimized. Financial starvation could indeed be one way for governments to curtail their fiscal council. On this dimension, well-established fiscal councils fare better than more recent creations, in part reflecting the inertia inherent to the dynamics of public institutions (Figure 4, bottom left panel). Pre-2005 councils are often larger in terms of staff, although there is considerable cross-country heterogeneity (Figure 4, bottom right panel). Budgets are also more likely to be protected from retaliatory cuts among older councils. Guarantees on the fiscal council’s resources range from having a separate budget line subject to vote in Parliament, to multi-year appropriations and even extra-budgetary financing—e.g. through the central bank, as in Austria and the Slovak Republic.¹⁴

30. Legal independence and safeguards on resources tend to be associated with specific monitoring and assessment tasks and a high media impact. Table 1 below shows the proportion of councils with the characteristic in line that simultaneously exhibit the characteristic in column. The vast majority of fiscal councils benefitting from some form of protection on their budgetary allocations also have strong legal guarantees of independence and a high media impact (roughly 80 percent). By contrast, only a minority of legally independent councils have their resources protected from possible retaliatory cuts, although there remains a comfortable majority to have media impact. Safeguards on the council’s budget thus seem to offer a useful complementary signal of genuine independence. Legal independence is also frequently associated (two-way associations) with the council’s involvement in forecasting and in monitoring compliance with fiscal rules, two activities which require a strong public perception of independence to be meaningful.

Table 1.

Selected Combinations of Fiscal Councils’ Characteristics

Sources: IMF Fiscal Council Dataset, and staff calculations.

Table 1.

Selected Combinations of Fiscal Councils’ Characteristics

	Legal independence	Safeguards on budget	Compliance with rules	High media impact	Forecast assessment
Legal independence	1.0	0.4	0.7	0.7	0.7
Safeguards on budget	0.8	1.0	0.4	0.8	0.7
Compliance with rules	0.9	0.3	1.0	0.6	0.6
High media impact	0.8	0.8	0.6	1.0	0.7
Forecast assessment	0.9	0.7	0.6	0.7	1.0

Sources: IMF Fiscal Council Dataset, and staff calculations.

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Table 1.

Selected Combinations of Fiscal Councils’ Characteristics

	Legal independence	Safeguards on budget	Compliance with rules	High media impact	Forecast assessment
Legal independence	1.0	0.4	0.7	0.7	0.7
Safeguards on budget	0.8	1.0	0.4	0.8	0.7
Compliance with rules	0.9	0.3	1.0	0.6	0.6
High media impact	0.8	0.8	0.6	1.0	0.7
Forecast assessment	0.9	0.7	0.6	0.7	1.0

Sources: IMF Fiscal Council Dataset, and staff calculations.

31. Despite the fairly high frequency of guarantees on independence, only a minority of fiscal councils are subject to formal accountability frameworks. Like in the case of central banks, explicit accountability requirements could imply regular hearings of the council’s head before parliamentary committees,¹⁵ explicit reporting procedures—e.g. in case of a large forecast error made by the council—and independent oversight of the council’s performance—including peer reviews or self assessments (like in the Canada, United kingdom or the Slovak Republic).

32. No clear trend has emerged as regards other key dimensions of governance, such as managerial appointments and decision rules (Figure 5). Fiscal councils’ management is often appointed by the executive, although government’s discretion is sometimes limited, such as in Sweden, where the outgoing chair proposes suitable replacements to the Finance Minister. A growing number of countries have opted for electing council members by parliament, which may offer a stronger guarantee against executive interference during the tenure of council members. In some rare cases, appointments are made by the head of state, or independent institutions, such as the central bank or the audit office. Once in place, many fiscal councils operate as committees making decisions by consensus or majority voting. In a few cases, council members can publicly express dissenting views. In a fair number of countries—typically those with parliamentary budget offices—the chairperson has been given a dominant role.

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Aspects of Governance

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Source: IMF Fiscal Council Dataset. Coverage varies with data availability.

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Fiscal Performance

42. As the existence of a fiscal council is often associated with a fiscal policy rule, it is essential to disentangle the potential impact of the council from the influence of a fiscal rule. The link between fiscal institutions (rules and councils) and fiscal performance is studied in the context of panel regressions estimated on a large sample of advanced and emerging economies. The regression approach allows taking into account other determinants of the primary balance, such as the output gap and the level of the public debt (see Appendix I). The potential impact of fiscal councils is tested via binary variables (0–1) identifying observations (in time and across countries) associated with a fiscal council in general or with a council that exhibits only certain characteristics. For fiscal rules, an index building on the dataset compiled by Schaechter and others (2012) is used. The index is constructed to measure the extent to which the rule shows features expected to constrain the financial position of the general government (e.g. a constitutional basis).

43. The econometric analysis suggests that certain characteristics of fiscal councils are associated with stronger fiscal performance, but that the mere existence of a council is not. (See Appendix I.) On average, and taking into account the impact of fiscal rules and other determinants of fiscal behavior, having a fiscal council as such appears only loosely related to stronger fiscal outcomes: the (conditional) correlation is positive but not statistically significant (see Figure 8). By contrast, significantly higher primary balances are associated with fiscal councils featuring certain characteristics. Note that because fiscal councils generally combine several of these features, this simple regression analysis does not identify “sufficient conditions” for effectiveness. For instance, the task of monitoring compliance with fiscal rules (point b) is unlikely to be sufficient to impact fiscal performance if it is not paired with strict independence and a presence in the public debate.

• a. Legal and/or operational independence. This result is particularly strong if one considers countries providing legal guarantees on the independence of their councils, and those allowing for a staff commensurate to the tasks of the council—an important element of operational independence. While it was argued earlier that explicit safeguards on funding were useful to avoid retaliatory cuts, this feature alone does not seem to characterize the most effective councils in the sample.

• b. Monitoring compliance with fiscal rules. The positive and quantitatively large effect seemingly associated with such fiscal councils is consistent with the likely beneficial combination of the two types of arrangements. That said, the strength of that potential complementarity could not be directly estimated.¹⁹

• c. Assessing or producing forecasts. This result is arguably linked to the previous one, as overoptimistic forecasts are often a way for governments to escape to the strictures of numerical fiscal rules (Frankel and Schreger, 2013). Although this only increases ex-ante compliance with the numerical targets, the cost of non-compliance ex-post is generally low given the weak enforcement mechanism characterizing many fiscal rules.

• d. Strong media presence. This result is consistent with the fact that the effectiveness of a fiscal council hinges importantly on the reputational and electoral impact of its analysis for policymakers.

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Fiscal Councils and Fiscal Performance

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Source: IMF staff estimates (Appendix I).Note: light-colored bars indicate that the estimated marginal impact of the binary variable is not statistically different from zero.

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44. In addition to the existence of fiscal councils with certain characteristics, fiscal rules are also associated with higher primary balances, reinforcing the earlier suggestion that rules and councils could each contribute in their own right to fiscal performance. On top of the positive association between key characteristics of fiscal councils and fiscal performance, fiscal rules designed to be more binding—i.e. greater values of the fiscal rule index—are positively associated with primary balances (Figure 9). This result echoes Fabrizio and Mody (2006) and Debrun and others (2008) who also found positive relationships between their respective fiscal rule index and fiscal outcomes in much smaller samples of European Union countries. This suggests that fiscal discipline might be better served by a combination of a council and a rule rather than by any one of them in isolation.

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Fiscal Rules and Fiscal Performance

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Source: IMF staff estimates1/ The chart illustrates the conditional correlation between the primary balance and the fiscal rules index based on the regression analysis in Appendix I. The “adjusted” primary balance takes into account all the other determinants of the primary balance included in the regression, in particular the output gap, the debt level, and the existence of a fiscal council.

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The Media Channel

45. Evidence that a high media presence of the council tends to be associated with stronger fiscal performance calls for further analysis of that channel of influence. Two main questions arise. First, is there any evidence that certain features of the fiscal framework—including the council itself—favor a strong media presence? Second, does a fiscal council communicate when it should? The rationale for the second question is that an effective communication strategy aims at minimizing the noise-to-signal ratio, implying that a fiscal council would be expected to avoid issuing frequent press statements about any random event likely to affect the budget. The variable used to assess the council’s media presence is a standardized and filtered count of references to the fiscal council in newspapers. Filters include the need for the reference to be associated with a number of keywords referring to fiscal policy in the same press article (see Appendix II).

46. Despite a more limited sample and the noise inherent to data on media counts, a number of interesting correlations and tentative conclusions emerge.

• a. Independent fiscal councils appear more likely to influence the public debate on fiscal policy. The councils deemed independent in the Fiscal Council Dataset have on average a higher media presence score than the others (Figure 10). This suggests that the credibility of the council as a non-partisan watchdog is an important condition for its views to be reflected in the public debate. This result is consistent with earlier econometric evidence on fiscal performance and provides an indication that the media would be an effective vehicle of the council’s influence.

• b. Fiscal councils operating in countries where fiscal rules are designed to be more binding tend to be more present in the press. (See Figure 10.) Although subject to clear statistical caveats (small sample and role of outliers), this result echoes earlier econometric evidence suggesting a quantitatively and statistically stronger association between fiscal outcomes and councils when those have a large media presence. It could also indicate that fiscal rules can facilitate the council’s work and communication by providing a simple benchmark against which plans and policies can be assessed.

• c. Evidence pertaining to the focus of fiscal councils’ interventions is less convincing. Working on a smaller sample of mature European fiscal councils and two case studies, Debrun, Gérard and Harris (2012) found that fiscal councils tended to be more vocal in the press when significant fiscal developments were taking place—large slippages or announced changes in the fiscal stance—and around the most important steps of the budget process. This is less clear for the overall population of councils gathered in this paper’s dataset, which exhibits only a weak positive correlation between the planned change in the overall fiscal balance and media presence (Figure 11). Several case studies discussed in the next subsection nevertheless shed a more positive light on the focus of council’s communication

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Determinants of Media Presence

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Source: IMF staff estimates.Note: Vertical axes measure for each group the average z-score of the number of media reports quoting the fiscal council along with relevant fiscal concepts (e.g. fiscal balance, deficit, public debt).

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Media Presence and Large Planned Policy Changes

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Source: IMF staff estimates.

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Fiscal Councils and Forecasting

47. As expected from earlier discussion, countries with fiscal councils tend to have more accurate and less optimistic macroeconomic and budgetary forecasts than others. This is particularly the case if the council has some of the main features seemingly associated with effectiveness (independence and high media impact) or if it is mandated to assess or produce forecasts and to monitor compliance with fiscal rules. This suggests that the potential impact of a fiscal council on fiscal performance could also operate through its capacity to avoid that governments use overoptimistic forecasts to deceive parliamentary oversight or circumvent fiscal policy rules.

48. Precision and bias are measured for 3 key variables: the primary balance, the cyclically-adjusted primary balance, and real GDP growth. A thorough discussion of the underlying econometric evidence—which expands the work of Jonung and Larch (2006) and Frankel and Schreger (2013)—is provided in Appendix II. Greater precision is evident from Figure 12 where the absolute forecast errors for all 3 variables are systematically lower in countries with a fiscal council featuring one of the 4 selected characteristics. Likewise, Figure 13 shows that fiscal councils contribute to unbiased or slightly conservative forecasts for primary balances, while other countries have overoptimistic projections on average. Interestingly, real growth forecasts remain overoptimistic,²⁰ suggesting that the presence of a fiscal council tend to encourage more conservative budgetary forecasts only. This may reflect the fact that manipulations of basic macroeconomic forecasts tend to be more easily detected given the many alternative sources providing similar forecasts. By contrast, estimating the budgetary impact of economic activity is technically more involved and offers more opportunities for manipulation. This result could also be related to the potential impact of the council’s presence on fiscal behavior itself, as greater transparency reduces incentives to deviate from ex-ante targets.

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Absolute Forecast Error and Selected Fiscal Councils’ Characteristics

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Source: IMF staff estimates.

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Mean Forecast Error and Selected Fiscal Councils’ Characteristics

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Source: IMF staff estimates.Note: The forecast error is defined as the forecast minus the actual value so that a positive number for the mean error indicates an optimistic forecast.

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Designing Effective Fiscal Councils

50. Each institution’s design needs to be adjusted to country-specific legal and political contexts and traditions. While the United States’ CBO has served as a model for other fiscal councils (Korea, Mexico, Canada and Hungary), in each case countries have sought to adjust the model to their particular system with different degrees of success. In Korea and Mexico, the PBOs are well established. In Hungary and to a lesser extent Canada, the councils faced challenges to their independence. In Canada’s case these issues reflect the difficulty of transposing the CBO model to a parliamentary system of government.

51. One size does not fit all. The impetus for creating fiscal councils varies across countries. The initial conditions leading to the establishment of a fiscal council determine its remit, the initial focus of its work, and how its performance and effectiveness are judged by politicians and the public. Although the theoretical literature focuses on establishing fiscal councils to address the roots of excessive deficits and debts, in practice, councils are created for a broad range of reasons which are both political and economic in nature. While a number of newer fiscal councils were established in reaction to an acute economic crisis, several others emerged as part of wider reforms aimed at addressing political issues. The countries with presidential systems (Korea and the United States) have established their council in a context of strengthening legislative oversight of the executive by providing expertise on fiscal issues.²¹ In the United Kingdom, the main motivation was to improve forecasts, and in Australia, to cost the electoral proposals of the government and the opposition political parties. As the experience of older fiscal councils demonstrates, however, the initial remit can evolve over time as councils gain new tasks.

52. For new councils, a strong legal basis for independence is important to give them time to become established and build reputational capital. The two oldest councils, the Belgian High Council of Finance (HCF) and the Dutch Bureau for Economic Analysis (CPB) have no or limited legal guarantees of independence, but in practice they have operated independently for decades and build up a reputation for good quality non-partisan analysis. Newer councils—for example Sweden and Canada—benefitted from a strong legal basis for independence. As the case of Canada illustrates, ambiguities in the mandate, guarantees of independence or relationship with the political principal must be avoided.

53. Political interference is not uncommon. In case of conflicts between the government (or the legislature) and the fiscal council, politicians have not hesitated to curtail independence. This has been done by cutting the council’s resources, controlling its work program, delaying appointments of members, or changing its size and mandate altogether.²² The most egregious example is the Hungarian fiscal council, which in its second year of existence, had its mandate restricted and staff virtually eliminated. The Belgium HCF made recommendations which were at odds with government’s objectives and experienced a two year delay in the appointment of key members. Canada and Sweden also faced threats to their budget after being critical of government policies.

Resources and Remit

54. Resources commensurate to the remit and tasks of the fiscal councils are essential for its effectiveness. The various tasks of a fiscal council have very different resourcing requirements. In Sweden, fiscal policy assessments have been performed by a staff of 5 at the overall cost of about USD 1 million (including the outsourcing of some background studies). At the other end of the spectrum, policy costing is the most resource intensive and time consuming activity requiring a larger and highly specialized staff. In the US, the CBO has a staff of 240, and a budget of USD 45 million to prepare costing of legislative proposals in addition to fiscal policy analysis, forecasts and long-term sustainability assessments.

55. Although it is difficult to formulate specific guidance on the optimal size of a fiscal council, some broad principles can be outlined. The quantitative ranges given below are for professional staff experienced enough to garner the respect of other experts and commentators of fiscal issues within the relevant country (Figure 14). These ranges are purely based on experience with existing fiscal councils and could vary substantially with the size and complexity of the government system and the institutional coverage of the council’s activities.

• Undertaking an assessment of fiscal policy, including compliance with fiscal rules, demands relatively few resources, say 2 to 10 full-time professionals.

• Similarly, assessing economic and fiscal forecasts can be done with a relatively small resource base by comparing the government’s forecasts to those of other high quality institutions. Moreover, simple forecasting tools are sufficient to raise alarms when the government’s budgetary forecasts seem out of line without obvious reasons.

• As the remit is extended to producing independent economic and fiscal forecasts, the resourcing requirements increase significantly, as more sophisticated models and specific expertise—e.g. on certain tax issues—are needed. Although much depends on the extent to which the council can rely on outside expertise (central bank or ministry), experience suggest that fiscal councils involved in forecasting operate at the minimum over 20 professional staff.

• Finally, policy costing is the most resource intensive and time consuming remit requiring a larger staff base, with an expertise in revenue and expenditure policies, combined with access to data and models that have often taken decades to develop within ministries of finance. To the extent that strong guarantees of independence exist, these resourcing needs can be reduced through data and model sharing agreements with the government agencies which traditionally perform these roles for the government (Australia).

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Number of FTE Staff and Functions

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Sources: IMF Fiscal Council Dataset.

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Operational Lessons

56. To remain effective across political cycles, fiscal councils need to actively develop their non-partisan credentials. Political support across party lines for the creation of the council clearly reduces the risk of subsequent partisan threats. In Hungary, the reform of the council in 2010 could be related in part to the lack of strong bi-partisan support for the 2008 fiscal responsibility law, which established the council. Similarly the creation of the Swedish council was not supported by the opposition parties, who feared it would be a mouth piece of the government. However, the Council quickly established its independence through normative analysis critical of the government. The Dutch CPB and the United States’ CBO have instead sought to avoid normative analysis. In the case of the CBO, this neutral position helped build a reputation of non-partisanship, which has been critical to its survival and impact.

Assessment of Fiscal Policy

57. For fiscal councils to influence the policy debate it is important to have a strong media presence to communicate their assessment of government’s fiscal policy to the public. This is particularly important when fiscal councils need to raise the alarm as when proposed budgets are not in line with stated objectives, when forecasts are over-optimistic and unlikely to be realized, when unsustainable spending or tax policies are being debated, or when the fiscal outturns are coming out significantly worse than projected. By identifying such episodes, and mapping them against the volume of media reporting of the findings of the council, it is possible to get a sense of the effectiveness of the council’s communication with the public. The Dutch experience through the 2000s provides a good example of effective communication, with the council increasing its public activity, as evidenced by spikes in media reports, at the specific points of time where fiscal policy was going off course (Figure 15).

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Media Reports of the Dutch CPB (Number of media articles relative to 4-year rolling average)

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Sources: Factiva and IMF staff calculations.

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58. While fiscal councils should have a steady media presence, it is important to ensure that key messages on fiscal policy are focused and provided when they matter most during the budget process. If media interventions focus on topics outside of the council’s immediate remit and become too numerous, this can reduce the power of their messages when fiscal policy is actually veering away from stated goals. The Dutch CPB is an example of an effective approach. Its interventions systematically take place around the release of its most extensive reports, in March and September—key points in the framing and passage of the budget (Figure 16). Similarly, the CBO’s interventions are focused around press briefings twice a year in February and August, when the budget and economic outlook updates are released. The director and staff of the CBO are also easily accessible for journalists, providing background briefings to ensure that they understand the work.

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Average Seasonal Pattern of Media Reports

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Sources: Factiva and IMF staff calculations.

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59. Councils tend to have a stronger impact when combined with a political and public consensus on sound public finances. In Sweden and Canada, there is a public consensus on the need for sound public finances, a legacy from their experiences of economic crises in the 1990s. Politicians are aware of the electoral risks of running deficits and emphasize balancing the budget. A similar consensus exists in the Netherlands. This has the advantage that when the councils raise the alarm, the media are more likely to pay attention. In contrast, when fiscal discipline is not well-anchored in electoral preferences, the task of the council is more difficult. In Belgium, the recommendations of the High Council of Finance had a major influence over fiscal policy when politicians focused on the fiscal convergence criteria to enter the euro area in 1999. That influence dramatically weakened in the immediate post euro era, culminating in the council providing strong public critical assessments of the government’s fiscal policies.

60. Clear benchmarks that fiscal performance can be judged against increase the traction of the council. These benchmarks often emanate from a fiscal rule, such as the Swedish expenditure ceilings or the SGP deficit ceilings, or other public commitments such as the deficit ceilings that are part of Dutch coalition agreements. Rules reduce the risk for the council of being perceived as partisan. Without such benchmarks, the council may find it difficult to leverage its positive analysis. In the United States, the absence of medium-term political commitments on fiscal outcomes along with other factors has limited the CBO’s capacity to influence politicians to constrain deficits (Hemming and Joyce 2013).

Forecasting

61. Case studies generally support the econometric findings that fiscal councils have more accurate forecasts, albeit with some cross-country variations. In the US, both the CBO and the Administration have a long track-record of preparing economic and fiscal forecasts. For the two-year ahead forecasts of real GDP, the CBO has a slightly pessimistic bias, compared to a slightly optimistic bias for the administration, with the CBO’s forecasts proving only marginally more accurate. That said, the degree of optimism in the Administration’s forecasts is relatively small compared to other advanced economies, and is largely limited to the early 1980s. Over a longer-term forecasting horizon, the administration’s bias is slightly more pronounced, but comparable to the bias in CBO or Consensus forecast (Table 3). Of course, the very presence of the CBO forecasts may have a disciplining effect against bias in the Administration own forecasts, though the revenue forecasts in the pre-CBO period didn’t appear to have any major bias.

Table 3.

United States: CBO and Administration Real GDP Forecast (1982–2010)

Sources: CBO, 2013, CBO’s Economic Forecasting Record: 2013 Update, January 2013.

Table 3.

United States: CBO and Administration Real GDP Forecast (1982–2010)

	Real GDP Forecast Error
	Average		Absolute Error
	2-year	5-year	2-year	5-year
CBO	-0.1	0.1	1.1	0.9
OMB	0.1	0.3	1.2	1
Blue Chip Consensus	-0.1	0	1.1	0.9

Sources: CBO, 2013, CBO’s Economic Forecasting Record: 2013 Update, January 2013.

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Table 3.

United States: CBO and Administration Real GDP Forecast (1982–2010)

	Real GDP Forecast Error
	Average		Absolute Error
	2-year	5-year	2-year	5-year
CBO	-0.1	0.1	1.1	0.9
OMB	0.1	0.3	1.2	1
Blue Chip Consensus	-0.1	0	1.1	0.9

Sources: CBO, 2013, CBO’s Economic Forecasting Record: 2013 Update, January 2013.

62. The quality of government forecasts improved after the establishment of fiscal councils in Canada and Sweden. Interestingly though, both countries exhibited a pessimistic bias in the government’s forecasts prior to the council’s introduction. Beginning in 2008, the Canadian PBO began producing its own economic and fiscal forecasts that immediately disciplined the government’s forecasting exercise, with forecasts becoming more accurate and less pessimistic (Figure 17). Over a similarly short period of time, a move from overly pessimistic fiscal balance forecasts (average bias of 1.6 percent of GDP pre-council) to a small optimistic bias of 0.2 percent followed the introduction of the Swedish Fiscal policy Council.

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Canadian Government’s fiscal forecast errors 2000–2010

(Percent of GDP)

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Sources: Canadian budget, PBO and staff calculations.

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63. The independent macroeconomic forecasts from the Belgian and Dutch fiscal councils in general have been more accurate than elsewhere in the European Union. Over the ten years prior to the crisis, there was a small pessimistic error in real GDP forecasts on average in the short term, with a slightly optimistic error as the forecast horizon extended. These average errors were relatively low compared to other European countries, although it must be noted that they were matched by countries with no fiscal council (Figure 18).

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EU Average Real GDP Forecasting Error 1998–2007

(percent of GDP)

Citation: Policy Papers 2013, 063; 10.5089/9781498341493.007.A001

Sources : European Commission (SCPs) and authors’ calculations.

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