High Level Regional Policy Dialogue
Strengthening Domestic Anchors to Assist with Crisis Exit Strategies

Washington, D.C., April 23, 2010

A substantial topic for discussion in 2009 centered around the appropriate strategies that countries – be they advanced, emerging or developing – should pursue to limit the after-shocks of the global economic crisis and to position their economies to resume steady growth paths. Ensuring future fiscal sustainability will be a challenge in the face of (a) reductions in tax revenues, (b) expenditure pressures caused either by fiscal stimulus measures or higher social expenditures, as automatic stabilizers kick in, and (c) likely higher borrowing costs, as greater competition for funds from other sovereign borrowers and reduced levels of international liquidity push up risk premiums. This has been well illustrated by the following extract from a recent IMF board paper on fiscal rules ¹:

“As countries exit from the crisis, the main challenge for fiscal policy is to develop credible strategies to strengthen public finances. The sharp increase in fiscal deficits and public debt in many countries has raised concerns about the sustainability of public finances. These are particularly acute given the underlying fiscal challenges, such as those arising from rapidly aging populations. There is, therefore, recognition of the need to put public finances back on a sound footing once recovery is assured. The credibility of the needed fiscal adjustment will be essential to anchor longer-run expectations about government solvency”.

Also mentioned in the extract above were structural problems being faced by many countries, not least of which are the effects of ageing populations which will add to the problems faced by policy makers in ensuring fiscal sustainability. Concern has been voiced about how to insulate policy makers from political pressures to allow them to make difficult – but necessary – policy choices likely to involve considerable fiscal restraint and, in some cases, tough fiscal adjustment programs.

A number of countries are looking at mechanisms, such as, (a) adoption of fiscal responsibility legislation, (b) fiscal rules, and possibly (c) independent fiscal agencies, to help to shield policy makers from political pressures to go for short-term political gain at the expense of long-term fiscal sustainability. In fact, a number of countries in the region – including Romania, Serbia, and Slovenia – are already considering these mechanisms to a greater or lesser degree, as part of their exit strategies.

In particular the use of fiscal rules has come sharply into focus for emerging market economies, having proven useful in many advanced countries in the past ². This is illustrated in another extract from the aforementioned IMF Board Paper on fiscal rules:

“Fiscal rules are institutional mechanisms aimed at supporting fiscal credibility and discipline. While longstanding experience with rules concerns mainly advanced economies, there has been an increasing interest from emerging market and low-income countries.” ³

At the December workshop in Tirana, fiscal rules were discussed by a number of panelists and country participants. It was agreed that they have a role to play in many countries. At the same time a note of caution was sounded, particularly by the IMF panelists, about the need to ensure that the design of fiscal rules or decisions on whether to establish new fiscal agencies should be firmly rooted in the needs of individual countries.

In some case external anchors such as the fiscal rules incorporated in the EU’s Stability and Growth Pact ⁴ are the main drivers of long-term fiscal policy, but increasingly, there is an understanding of the role of domestically driven anchors and rules to meet specific country objectives and challenges. This is certainly not an area where “one size fits all” solutions can be prescribed and the rules developed by external agencies such as the EU, which in many cases were designed with more advanced economies in mind, may not be suitable in all cases. ⁵ In designing appropriate fiscal rules it is essential to ensure that long-term policy objectives are being met. Fiscal rules need to avoid encouraging pro-cyclicality and must be credible. If there is no underlying commitment to fiscal discipline, attempts to breach the rules through circumventing the rules – either through off-budget activities or simply ignoring the rules – are likely to emerge. In isolation fiscal rules can be regarded as somewhat inflexible and therefore broader reforms – of which the introduction of fiscal rules is one element – may be needed.

As a consequence, recent literature has focused on a combination of solutions, such as introduction of fiscal responsibility legislation and – importantly – the creation of independent fiscal agencies such as fiscal councils. Again a number of countries in the region are considering the fiscal council approach, following the most recent examples of Hungary (established in 2008) and Sweden (2007) as well as more readily established models such as the Central Planning Bureau in the Netherlands and Germany’s Fiscal Council.

Here too there has been a lot of debate as to whether a fiscal council is the right approach for emerging market economies – and if so – what should form the boundaries of their responsibilities. There is a concern that establishment of fiscal councils may serve to dilute limited capacity that already exists in existing fiscal institutions such as ministries of finance and that a better solution might be to seek to improve the policy advice capacity in existing institutions. There are also debates as to how “independent” these agencies should be and whether their role should be limited to a merely commenting on government fiscal policy, whether they should have a role in producing macroeconomic forecasts for inclusion in fiscal policy frameworks – or even more controversially – whether they should have an oversight role on the shaping of fiscal policy. The latter role is one that many commentators feel may be a step too far in removing fiscal policy discretion and, as importantly, responsibility from the hands of elected representatives to a group of unelected “wise men or women”.

These fundamentally important issues may have a strong bearing on the shape of fiscal policy design and implementation in the region in the immediate future. Having this in mind, the April 2010 High Level Regional Policy Dialogue in Washington would appear to be a very opportune and timely forum in which to continue to the discussion and to learn for regional country experiences and the experiences of countries in other regions.

¹ IMF Board Paper (December 2009) Fiscal Rules—Anchoring Expectations for Sustainable Public Finances. Washington DC: International Monetary Fund, pg. 4.
Available at: http://www.imf.org/external/np/pp/eng/2009/121609.pdf

² Over 80 countries are currently estimated to use some form of fiscal rule. (Source: IMF Board Paper (December 2009) Fiscal Rules—Anchoring Expectations for Sustainable Public Finances.)

³ IMF Board Paper (December 2009), pg. 4.

⁴ http://europa.eu/legislation_summaries/economic_and_monetary_affairs/stability_and_growth_pact/index_en.htm

⁵ For instance the Maastricht requirement for a general government debt ceiling of 60 percent of GDP may be too high for some countries with limited access to financial markets or lower credit ratings than advanced EU economies such as Germany or France.

In order to address fiscal rules in a broader manner, the following dimensions and challenges have to be taken into account and closely linked to the needed capacity building in the area of economic and fiscal policy design and implementation. Four aspects of fiscal policy design, in particular, appear to deserve deeper attention in this connection:

1. Development of baseline macro-economic projections and risk variants;
2. The design of short- and medium-term fiscal goals, taking into account policy experience gained during the recent crisis;
3. The challenge of ensuring that national fiscal plans integrate structural policy objectives and the introduction of the Acquis communautaire;
4. The needed focus on policy co-ordination structures for medium-term economic and fiscal plans.

High level participants at the Washington Seminar in April 2009 and practitioners at the Tirana Workshop in December 2009 agreed with the key role that strongly-anchored medium-term economic and fiscal programs need to play. But have countries in the region so far had a chance to develop the internal strategy and coordination processes to fully benefit from the EU anchor as they prepared integrated medium-term programs? In particular, has the design and implementation of fiscal policy been sufficiently coordinated with the broad goals of economic convergence in order to support both growth and financial stability?

Participants at the two above mentioned events agreed that attention should be paid to capacity building. They emphasized that effective policy design is a key responsibility of government and its institutions that cannot be outsourced. Developing skills and improving capacity in this area is in fact a fundamental policy task of every country!

Information received during the seminar in Washington and the workshop in Tirana forms a valuable input into a “Building Capacities in Policy Design and Implementation” project that will be proposed for execution over the next two to three years. The project proposal will be presented at the High Level Regional Policy Dialogue for further input from the high level participants.