International Experience withRules-Based Fiscal Frameworks:

Design Issues

George KopitsFiscal Council

Republic of Hungary

Conference on Fiscal Frameworks Mishkenot Shanamin Jerusalem, May 5, 2009

Outline

• Background

• RFF: key elements

• Policy rules, procedural rules

• Transparency

• Enforcement

• Country experience

• Performance

Background

Discretionary policy: problems

• Time inconsistency

• Free rider, common pool problem

• Deficit bias

• Procyclical bias

• Expenditure composition bias

• Unsustainable public debt

Background

Discretionary policy: economic effects

• Domestic imbalance (inflation, crowding out)

• External imbalance

• Macroeconomic volatility

• Low growth rate

• Financial crises (currency, bank, debt crises)

Key Elements of RFF

• Policy (numerical) rule: permanent constraint on a summary fiscal indicator

• Procedural rule: supporting regulation on budget process

• Transparency: functional, coverage, time horizon, accounting practices

• Enforcement: surveillance, sanctions for non-observance

Types of Policy Rules

Budget balance rules

• overall balance (incl. deficit limit, min. surplus)

• current balance (“golden rule”)

• primary balance

• operating balance

• medium-term, structural, or CA balance

Types of Policy Rules

Expenditure rules

• primary expenditure limit

• discretionary expenditure limit

• wage expenditure limit

Types of Policy Rules

Debt rules

• debt ratio limit

• target debt ratio primary surplus ratio

• real debt limit nominal primary surplus

Types of Policy Rules

Debt rules

Brazil: convergence to target debt ratio

given target debt ratio

derive target primary surplus ratio

tnt dd *

xdg

gis tt

1*

1

Types of Policy Rules

Debt rules

Hungary: real debt limit

given debt target

derive primary surplus target

and nominal surplus target (discretionary component)

0( *1

* tft

ftt DiS

33* 1( ttt DD

0** fttt SMSSR

Major Types of Procedural Rules

• medium-term budget planning

• pay-go principle for budget proposals

• limit on end-year carryover of appropriations

• rules on supplementary appropriations

Transparency(wide access to timely information)

• broadest coverage of public sector

• accounting for extra-budgetary operations

• accounting conventions (accrual vs. cash)

• forecasts (incl. realistic macro assumptions)

• institutional clarity (e.g., government functions, goals; intergovernmental relations,

transfers)

• contingent liabilities, risk assessment

Enforcement Mechanism

• statutory basis: constitution, law, guidelines

• implementation: – ex ante targets, ex post realization– escape clauses, contingency funds

• surveillance: self, independent authority, other

• sanctions: reputational, legal, financial

Criteria for Success

• well-defined set of rules• transparency• simplicity• adequacy to accomplish objective• consistency, internally and externally• flexibility with respect to shocks• enforceability• efficiency (that is, no distortionary effects)

Selected Country Practices

Basic Rule

Statute

Authority

Sanction

New Zealand operating balance (MT) law reputational EU (SGPact) overall balance (MT); debt limit treaty peer review financial Sweden structural surplus; primary exp. limit guideline fiscal council reputational Bulgaria overall balance; primary exp. limit guideline reputational Poland debt limit constitution judicial Chile structural surplus; stabilization fund law fiscal council reputational Peru overall balance; stab. fund; exp. limit law central bank judicial Brazil current balance; debt limit; wage limit law judicial India current balance; deficit limit law judicial Switzerland structural balance constitution judicial Hungary debt limit; primary expenditure limit law fiscal council reputational

Experience: Compliance

Good compliance: New Zealand, Brazil*, Bulgaria, Chile, Estonia, Norway, Peru,* Sweden, Canadian provinces, Swiss cantons, some Euro members

Mixed compliance: Colombia,* Poland, Euro area (incl. national rules), UK, US states

Poor compliance: Argentina,* Ecuador,* Venezuela*

Promising start: India,* Switzerland, Mexico, Nigeria,* Hungary*

Experience: Performance

In complying countries

• investor confidence

• moderate real interest rates

• relatively low inflation

• above-average growth, stability

• lower vulnerability to crises

• fiscal sustainability

• mixed results on external balance

Experience: Performance

In complying countries

• Creative accounting ?– rarely, not significant

• Pro-cyclical effects ?– in some cases where initial structural deficit, high

debt ratio, or postponed reforms

• Stop-gap measures or reforms ?– in some cases compliance through distortionary

measures (composition bias), where reforms postponed

Experience: Summing Up

• Mostly recent experience and “jury is still out”

• Basic tests: – compliance over a full economic cycle and political cycle– performance compared to counterfactual

• Identification problem, when applied in tandem with monetary rules (inflation targeting, fixed XR)

• On balance, experience has been positive