Bare Truth by Rose de la Cruz
Bare Truth

Simplicity in fiscal rules helps promote credibility

Oct 13, 2021, 3:46 AM
Rose De La Cruz

Rose De La Cruz


IN the October 7 IMF blog emailed to me, it was stressed that aside from working at ending the health crisis and addressing its immediate fallout, governments would also benefit from committing to fiscal responsibility.

Authors Raphael Espinoza, Vitor Gaspar and Paolo Mauro, the IMF blog noted efforts by the governments to extend massive fiscal support that has saved lives and jobs.

“As a result, public debt has reached historic highs, although it is expected to decrease marginally in the next few years. These developments raise questions about how high debt can go without being disruptive.”

Many countries now face heightened fiscal risks in record loans, guarantees, and other measures taken to protect firms and jobs from the fallout of COVID-19.

Such shocks put pressure on budgets and fiscal institutions such as fiscal rules, which need to be flexible to allow for larger deficits when needed. Well-designed risk mitigation strategies—such as restrictions on loan eligibility or limits on loan size and maturity—can reduce these risks or limit fiscal costs if they materialize.

But these frameworks must also ensure steadfast debt reduction in good times, so that fiscal support can be deployed again in the future, they stressed.

Greater predictability

IMF’s Fiscal Monitor insists that committing to sound public finances with a credible set of rules and institutions to guide fiscal policy, can facilitate fiscal policy decisions at the current juncture. When lenders trust that government are fiscally responsible, they make it easier and cheaper for countries to finance deficits.

This buys time and makes debt stabilization less painful, they said, such as when budget plans are credible (as measured by how close professional forecasters’ projections are to official announcements), borrowing costs can fall temporarily by as much as 40 basis points.

Even for governments that do not borrow from markets, fiscal credibility can attract private investment and foster macroeconomic stability.

Governments can signal their commitment to fiscal sustainability while addressing the ongoing crisis in various ways like undertaking structural fiscal reforms (example is subsidy or pension reform) or adopting budget rules and establishing institutions that are geared toward promoting fiscal prudence.

Debt shocks

When governments conceive and put in place budget rules and institutions, they should strive to consider all risks to the public finances. Debt sometimes increases beyond what is forecast in the baseline or somewhere between 12 and 16 percent of GDP at five-year projection horizons, the blog said.

Underlying such negative shocks are disappointing medium-term GDP growth and other drivers of debt, including bailouts of businesses and exchange rate depreciation.

Overarching goals

A robust set of budgetary rules and institutions should seek to achieve three overarching goals: sustainability, economic stabilization and for fiscal rules in particular, simplicity. But it is hard to fulfill all three at once.

Although simple numerical rules can be rigid, they promote fiscal prudence. For instance, countries that follow debt rules generally manage to reverse debt hikes of 15 percent of GDP in about 10 years in the absence of new shocks—significantly faster than countries that do not follow debt rules. Numerical rules need not rely only on debt: other indicators, such as the interest bill or the net worth of the government, can complement traditional debt and deficit indicators.

A country’s commitment to budget discipline and clear communication of policy priorities—backed by transparency about government spending and revenues—pays off.

Many countries suspended their fiscal rules in 2020 to rightly increase health care and social spending in addressing the pandemic. Our analysis of newspapers shows that media reporting of the suspension of fiscal rules was more positive in places with higher fiscal transparency.

The blog attested that strong budget rules and institutions, backed by clear communication and fiscal transparency, enhance credibility. That, in turn, improves access to credit and secures more room for maneuver in times of crisis.

Ultimately, fiscal frameworks are only effective if they have sufficient political support. Even so, they help focus discussions and can thus help reach political consensus on credible fiscal policies.

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