Paolo Mauro Fiscal Affairs Department International Monetary Fund

1. Paolo Mauro Fiscal Affairs Department International Monetary Fund Chipping Away at Public Debt Sources of Failure and Keys to Success in Fiscal Adjustment The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.

2. Motivation/Background • The state of the public finances in advanced economies: taking stock of where we are now and where we need to go.

3. Fiscal Outlook in Advanced Economies(in percent of GDP) 2.0 0.0 - 2.0 - 4.0 - 6.0 Overall Balance - 8.0 - 10.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 120 Gross Government Debt 110 100 90 80 70 60 2000 2002 2004 2006 2008 2010 2012 2014 2016

4. Fiscal Challenge: Stylized Facts The scale of the debt problem is unprecedented G-7 PPP-Weighted Public Debt, 1950-2016, percent of GDP Source: IMF FiscalMonitor April 2011

5. Germany Italy Netherlands CAPB 2010 (percent of GDP) France Req. CAPB by 2020 to reach 60% debt in 2030 Spain Req. CAPB to stabilize 2010 debt levels United Kingdom Portugal United States Ireland Greece Japan - 8 - 6 - 4 - 2 0 2 4 6 8 10 IMF Staff Calculations. Calculations for Japan based on net debt.

6. What we do in the book

7. Analytical Framework • Previous empirical studies identified fiscal adjustment episodes on the basis of ex post outcomes. • Instead, we approach fiscal adjustment plans on the basis of large envisaged reductions in debts and deficits. • One learns from successes but also failures. • Compare ex post outcomes with ex ante plans • Avoids sample selection / survivorship bias

8. What we do: two methods Individual Country Case Studies for each of the G7 countries Cross-Country Statistical Analysis for the three-year plans of all EU Countries, 1991-2007.

9. G-7 Fiscal Adjustment Plans

10. G-7 Fiscal Adjustment Plans

11. G-7 Fiscal Adjustment Plans Source: IMF staff compilations.

12. Public Sector New Borrowing and Debt in the U.K. (In percent of GDP)

13. Key Findings Findings in Three Dimensions: • Rationale for and design of the envisaged fiscal adjustment • Degree of implementation and underlying macroeconomic factors • Political and institutional determinants of the implementation record

14. Rationale for and Design of Fiscal Adjustment Plans • Envisaged composition of fiscal adjustment: • Most plans focused on spending cuts, consistent with the relatively large initial size of government, particularly in Europe. • Macroeconomic assumptions: • Macroeconomic assumptions were mostly in line with those of independent observers

15. Revenue and Expenditure Composition of 66 Plans (In Percent) Expenditure Revenue Increase Decrease Total Increase 10 27 37 Decrease 0 63 63 10 90 100

16. Rationale for and Design of Fiscal Adjustment Plans • Envisaged composition of fiscal adjustment: • Most plans focused on spending cuts, consistent with the relatively large initial size of government, particularly in Europe. • Macroeconomic assumptions: • Macroeconomic assumptions were mostly in line with those of independent observers

17. Implementation Record and Underlying Macroeconomic Factors • Implementation record and degree of ambition: • Evidence from study of 66 large adjustment plans in the EU sample: it is “OK to plan big.” • Ambitious plans do tend to produce more adjustment than do more modest plans, by a factor of one. • Revenue-expenditure mix in outcomes versus plans: • Expenditure cuts did not materialize to the extent envisaged. Revenues compensated in part. • Key role of economic growth: • Deviations of economic growth from initial expectations were a major factor underlying success or failure.

18. European Union: Planned and Actual Adjustments, 1991-2007(Percent of Potential GDP)

19. Implementation Record and Underlying Macroeconomic Factors • Implementation record and degree of ambition: • Evidence from study of 66 large adjustment plans in the EU sample: it is “OK to plan big.” • Ambitious plans do tend to produce more adjustment than do more modest plans, by a factor of one. • Revenue-expenditure mix in outcomes versus plans: • Expenditure cuts did not materialize to the extent envisaged. Revenues compensated in part. • Key role of economic growth: • Deviations of economic growth from initial expectations were a major factor underlying success or failure.

20. EU sample: Actual versus Planned Structural Fiscal Adjustment(Percent of potential GDP; means reported, except for implementation ratios, which are medians)

21. Implementation Record and Underlying Macroeconomic Factors • Implementation record and degree of ambition: • Evidence from study of 66 large adjustment plans in the EU sample: it is “OK to plan big.” • Ambitious plans do tend to produce more adjustment than do more modest plans, by a factor of one. • Revenue-expenditure mix in outcomes versus plans: • Expenditure cuts did not materialize to the extent envisaged. Revenues compensated in part. • Key role of economic growth: • Deviations of economic growth from initial expectations were a major factor underlying success or failure.

22. Baseline Regressions With Core Variables Dependent Variable: Implementation error = actual minus planned adjustment Fixed Effects FE Instrumental Variables (1) (2) (3) (4) (5) (6) VARIABLES Overall balance base effect -0.61*** -0.61*** -0.53** -0.82*** -0.85*** -0.53*** (0.17) (0.16) (0.19) (0.22) (0.24) (0.13) Initial fiscal balance -0.26 -0.38 -0.27* -0.39** (0.22) (0.24) (0.16) (0.18) Real GDP growth surprise 0.34*** 0.34*** 0.12 0.52*** 0.53*** -0.029 (0.059) (0.059) (0.13) (0.088) (0.094) (0.079) Plan ambition -0.37 -0.19 -0.29 -0.29 -0.14 -0.29 (0.47) (0.32) (0.47) (0.33) (0.29) (0.33) Deviation of initial deficit from 3% of 0.18 0.24 GDP level (0.18) (0.19) Time dummies Yes Yes Observations 66 66 66 66 66 66 R-squared 0.456 0.422 0.662 0.367 0.320 0.177 Robust standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1

23. Fiscal Institutions and Political Factors • Features influencing degree of implementation: • Monitoring of fiscal outturns and policy response to data revisions • Binding medium-term limits • Contingency reserves • Coordination across levels of government • Fiscal rules • Political Factors and Public Support for Fiscal Adjustment: • Lower fractionalization in the legislative body and perceptions of greater political stability are to some extent associated with better implementation of plans. • Public support is crucial for implementation success.

24. Implications for Planned Adjustments • Spelling out how policies will respond to shocks. • Monitoring and accountability: Implementation of plans should be supported by reliable and timely information. • The revenue-expenditure mix of fiscal consolidation plans needs to reflect country-specific societal preferences and structural fiscal characteristics. • Structural reforms underpin successful implementation of large fiscal adjustment plans. • Build public support—public support for fiscal adjustment, rather than a comfortable legislative majority, is what matters.

25. Thank you! To find out more: Chipping Away at Public Debt—Sources of Failure and Keys to Success in Fiscal Adjustment, Wiley.

26. Background Slides

27. Additional Regressions With Political Variables and Asymmetries Dependent Variable: Implementation error = actual minus planned adjustment FE Instrumental Variables VARIABLES (1) (2) (3) (4) (5) (6) Overall balance base effect -0.82*** -0.83*** -0.84*** -0.68*** -0.87*** (0.22) (0.22) (0.21) (0.21) (0.22) Initial fiscal balance -0.27* -0.27* -0.31 -0.39** -0.30** -0.30* (0.16) (0.16) (0.19) (0.16) (0.13) (0.17) Real GDP growth surprise 0.52*** 0.50*** 0.49*** 0.45*** 0.50*** (0.088) (0.089) (0.080) (0.088) (0.087) Plan ambition -0.29 -0.26 -0.33 -0.40 -0.46 -0.29 (0.33) (0.32) (0.33) (0.32) (0.28) (0.34) Positive overall balance base effect -0.92*** (0.34) Negative overall balance base effect -0.71** (0.31) Positive growth surprise 0.37 (0.29) Negative growth surprise 0.58*** (0.16) Fiscal rule strength 0.61** (0.30) Change in government stability 3.07*** (1.12) Parliamentary fractionalization -3.62* (2.09) Observations 66 66 66 66 66 65 R-squared 0.367 0.380 0.375 0.426 0.493 0.382 Robust standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1

28. Regressions with Outliers Removed Dependent Variable: Implementation error = actual minus planned adjustment Fixed Effects FE Instrumental Variables VARIABLES (1) (2) (3) (4) (5) (6) (7) (8) Overall balance base effect -0.70*** -0.82*** -0.72*** -0.87*** -1.22*** -0.85*** (0.20) (0.21) (0.20) (0.20) (0.34) (0.18) Initial fiscal balance -0.14 -0.13 -0.19 -0.30** -0.15* -0.14 -0.30** -0.30*** (0.11) (0.12) (0.11) (0.13) (0.091) (0.097) (0.12) (0.10) Real GDP growth surprise 0.38*** 0.37*** 0.34*** 0.54*** 0.52*** 0.45*** (0.056) (0.049) (0.048) (0.092) (0.090) (0.064) Plan ambition -0.0044 0.033 -0.076 -0.26 0.11 0.14 -0.16 -0.15 (0.19) (0.21) (0.19) (0.18) (0.16) (0.16) (0.20) (0.15) Positive overall balance base effect -1.64*** -1.69*** (0.47) (0.47) Negative overall balance base effect -0.46** -0.64** (0.18) (0.25) Positive growth surprise 0.21** -0.087 (0.090) (0.30) Negative growth surprise 0.48*** 0.82*** (0.066) (0.23) Fiscal rule strength 0.41* 0.38** (0.23) (0.16) Change in government stability 2.68*** 2.25*** (0.82) (0.70) Parliamentary fractionalization -0.47 -1.18 (2.64) (1.67) Observations 58 58 58 57 58 58 58 57 R-squared 0.582 0.611 0.602 0.713 0.496 0.534 0.437 0.665 Robust standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1

29. Advanced economies: Illustrative scenarios for primary balance adjustment and debt 6 4 2 0 - 2 Cyclically Adjusted Primary Balance - 4 Primary Balance - 6 - 8 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 100 90 80 70 60 50 General Government Gross Debt – to – GDP ratio 40 30 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029