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Considerations for designing a fiscal consolidation strategy

Considerations for designing a fiscal consolidation strategy. Douglas Sutherland OECD Economics Department. The starting point What consolidation is already underway The end point Fiscal gaps How to get there Past experience and general principles . Third wave of large deficits in OECD.

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Considerations for designing a fiscal consolidation strategy

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  1. Considerations for designing a fiscal consolidation strategy Douglas Sutherland OECD Economics Department “Fiscal consolidation, policy framework and governance” Policy Workshop IMAD, Ljubljana

  2. The starting point • What consolidation is already underway • The end point • Fiscal gaps • How to get there • Past experience and general principles

  3. Third wave of large deficits in OECD

  4. Today’s challenges Top panel – required change in the primary balance as % of GDP to stabilise debt Bottom panel – gross debt as percent of GDP. OECD Economic Outlook 88

  5. Spending and revenues have reached a plateau?

  6. Large consolidations already underway OECD Economic Outlook 2011

  7. Short-run impacts on growth • Multiplier-type effects • Short-run contractionary impact • Monetary policy and financial markets • Alone or simultaneous consolidation • Non-Keynesian effects • Key messages not in dispute

  8. Consolidations and growth Growth before and after fiscal consolidation, based on different definitions Bottom panels when consolidation succeeds in stabilising debt at time t +1 or +3

  9. Expansionary contractions Finland – 3 episodes of “expansionary fiscal contractions”

  10. Difference with past episodes • Debt reaching unprecedented levels • Not just stabilisation • Prudential debt targets/ceilings • Allow automatic stabilisers to operate fully • Minimise deadweight losses • Absorb shocks • Respect intergenerational fairness

  11. Other spending pressures • Demographic and other pressures on public spending • Pensions • Health and long-term care • Contingent liabilities

  12. Fiscal gaps Simple model structure

  13. Baseline simulations

  14. Adding spending pressures Note: Greece is pre-retirement reform

  15. Sensitivity analysis • Costs of delay or stalled consolidation • Fiscal shocks and contingent liabilities • Risk premia • Higher productivity • Delayed retirement

  16. Sustained consolidation • Bernanke (6/7/2011) • …the appropriate response is to move quickly to enact a credible, long-term plan for fiscal consolidation. By taking decisions today that lead to fiscal consolidation over a longer horizon, policymakers can avoid a sudden fiscal contraction that could put the recovery at risk.

  17. Large consolidations Developments before and after the start of large consolidations, based on trough-to-peak of underlying primary balance

  18. Challenges • Sustained effort needed • Enhance efficiency to support long-term growth • More efficient distributional instruments • Greater spending efficiency • Less-distortionary taxation/user fees

  19. Better distributional policies Milligan and Wise (2011)

  20. More efficient spending Joumardet al (2011)

  21. Less distortionary taxation Recurrent tax revenues from immovable property

  22. Supporting consolidation • Econometric evidence (Molnar) • Growth and interest rates • Spending cuts associated with debt stabilisation (large consolidations are associated with rises in revenue as well) • State-level governments can help • Fiscal rules (combinations of spending rules and budget balance requirements)

  23. Wider fiscal framework • Good budgetary practices • Fiscal rules • Other fiscal institutions

  24. Thank you Douglas Sutherland@oecd.org

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