Fiscal Policy Councils: Unlovable or Just Unloved?

1. Fiscal Policy Councils:Unlovable or Just Unloved? Charles Wyplosz Graduate Institute of International Economics and CEPR Conference on Fiscal Rules and Institutions Ecnomic Council of Sweden, October 22, 2007

2. The problem

3. Not universal or not permanent

4. Not new

5. Why? • Common pool interpretation • Grab for resources • Captured governments • Time inconsistency • Political expediency • Future taxpayers don’t vote • Discretion is the problem

6. Rule it out? • Numerous proposals • Balanced-budget rule • Golden rule • Stability pact and other ceilings • A rule is bound to be counter-productive one day • Fiscal policy is also a counter-cyclical policy instrument

7. Rationale for FPCs • The monetary policy solution • Long-term goal, short-run flexibility Inflation targeting Price stability Taylor rule

8. Rationale for FCPs • The fiscal policy council solution • Long-term goal, short-run flexibility Debt targeting Inflation targeting Debt sustainability Price stability Taylor rule Annual deficits

9. Implementation • An independent body • A clear mandate • Long-term debt • Set by the elected government at the beginning of its legislature • An instrument • The path of budget balances – Nothing else • Annual decisions take into account situation • End-of-period objective is binding

10. Soft variant • Advisory role • FPC makes recommendations, government decides • FPC then evaluates outcomes • Effectiveness rests on public debate • FPC as pro-discipline pressure group • Can work if other pressure groups not too powerful • Examples: • Belgium, Denmark, Chile, and now Sweden

11. Soft variant • Advisory role • FPC makes recommendations, government decides • FPC then evaluates outcomes • Effectiveness rests on public debate • FPC as pro-discipline pressure group • Can work if other pressure groups not too powerful • Examples: • Belgium, Denmark, Chile, and now Sweden

12. Soft variant • Advisory role • FPC makes recommendations, government decides • FPC then evaluates outcomes • Effectiveness rests on public debate • FPC as pro-discipline pressure group • Can work if other pressure groups not too powerful • Examples: • Belgium, Denmark, Chile, and now Sweden

13. Hard variant • Decision power on budget balances • Government and parliament bound to adopt budget in line with Council’s decision • Council does not express view on spending and tax levels and structure • FPC accountable ex-post • Unclear sanctions (cf central banks) • Examples: none

14. Other arrangements* • Expert judgment not incorporated in decision process • Germany (Council of Academic Experts) • USA (CBO) • Japan (Fiscal System Council) • Netherlands (CPB) • Korea (c.f. CBO) • Mexico (c.f. CBO) • and more… (*) Source: IMF

15. Other arrangements

16. Why so unloved? • Fiscal policy is a political prerogative of elected officials • Microeconomic effects: important redistributive effects • Macroeconomic effects: • Not more redistributive than monetary policy • Intergenerational redistribution problematic • Bureaucrats cannot be made accountable • Same as independent central banks

17. Why so unloved? • Principle hard to implement • How to avoid ex post slippages? • Will lead to tougher decisions • Sets incentives straight • Debt objective can be too ambitious • Trade-off between being too modest ex ante and too restrictive ex post • Sets incentives straight • Risk of backsliding • FPC can be disbanded • Sets incentives straight

18. Why so unloved? • Misunderstanding • Difference between micro and macro effects • Micro-level flexibility under threat • Well understood but pressure groups too powerful • An argument for the Stability Pact • But also an argument for a modified pact • Decentralize the pact • Rely on country-level FPCs

19. Can it be lovable? • Strong logic • Delegation as a solution to time inconsistency and pressure groups • Deals with political failure • Second-best features • But lack of sufficient experimentation • Now under way