Fiscal adjustment in EU countries: A Balance Sheet Approach

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Fiscal adjustment in EU countriesA Balance
Sheet Approach

• Gian Maria Milesi-Ferretti
• Kenji Moriyama
• International Monetary Fund

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Motivation

• Debate on the design of fiscal rules and reforms
  of the SGP
• Frequent adoption of creative accounting
  measures
• Proposals to move fiscal accounting towards a
  balance sheet approach
• (e.g., new GFS manual) or to exclude
  investment from deficit calculations

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What the paper does

• Sketches government balance sheet
• Defines cosmetic (nonstructural) fiscal
  measures
• Provides examples
• Presents empirical evidence on the evolution of
  net worth in EU countries up to 1997 and
  thereafter

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(No Transcript)
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A balance sheet approach

• Stocks

Assets Liabilities

Public capital Gross financial liabilities Gross government debt Debt held by publ. inst. Other
Gross Financial assets Gross financial liabilities Gross government debt Debt held by publ. inst. Other
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A balance sheet approach (contd)

• Flows
• Change in net worth
• Flow change in financial assets
• Flow change in financial liabilities
• Net public investment
• valuation effects

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Key issue

• Valuation of public capital
• Market value (desirable)
• Book value (feasible)
• Financial returns on public capital lower than on
  public debt

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Intertemporal budget constraint

• W(t)net worth
• G(t)government spending
• T(t)government revenues

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Cosmetic measures

• Measures that improve the fiscal balance and/or
  reduce gross government debt....
• But do NOT reduce the present value of future
  taxes needed to finance future spending and repay
  existing debt

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Examples of cosmetic measures

• Sale of public assets
• Securitization operations
• Capital injections and recapitalization
• Off-budget items
• Quasi-fiscal activities

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Change in government balance sheetskey questions

• Did fiscal rules lead to fiscal adjustment?
• Are changes in government debt improving net
  worth?
• Which countries have relied more heavily on sales
  of public assets?

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Empirical approach

• Collection of data on cosmetic measures
  difficult to undertake
• Hence indirect approach compare Maastricht
  variables with dynamics of net worth

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Limitations of approach

• Misses reforms that alter future taxes and
  spending (e.g. pension reforms)
• Large measurement problems
• Symmetric reductions of public assets and
  liabilities may be desirable (e.g. privatization)

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Political economy insights

• creative accounting measures more likely when
  rules are more stringent
• Optimistic forecasts more likely when governments
  discount the future more heavily

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Change in public assets and initial debt, 1992-97
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Change in public assets and liabilities, 1992-97
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Changes in net worth and changes in liabilities,
1992-97
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Change in public assets and liabilities, 1997-2002
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Changes in govt liabilities and net worth,
1997-2002
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Growth forecast and budget balance
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Summary of findings

• 1992-1997 Changes in financial liabilities
  reflect primarily changes in public assets
• 1998-2002 Change in financial liabilities reflect
  primarily changes in net worth
• Governments with more serious fiscal problems
  tend to be more optimistic than markets about
  growth prospects

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Conclusions

• Fiscal rules can be helpful...
• But it is important to understand the incentives
  they set in place....
• ...and monitor fiscal developments more broadly