Fiscal adjustment in EU countries: A Balance Sheet Approach

1. Fiscal adjustment in EU countries:A Balance Sheet Approach Gian Maria Milesi-Ferretti Kenji Moriyama International Monetary Fund

2. 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

3. 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

5. A balance sheet approach • Stocks:

6. 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

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

8. Intertemporal budget constraint • W(t)=net worth • G(t)=government spending • T(t)=government revenues

9. ‘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

10. Examples of ‘cosmetic’ measures • Sale of public assets • Securitization operations • Capital injections and recapitalization • Off-budget items • Quasi-fiscal activities

11. Change in government balance sheets:key 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?

12. Empirical approach • Collection of data on ‘cosmetic’ measures difficult to undertake • Hence indirect approach: compare “Maastricht variables” with dynamics of net worth

13. 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)

14. Political economy insights • “creative accounting” measures more likely when rules are more stringent • Optimistic forecasts more likely when governments discount the future more heavily

15. Change in public assets and initial debt, 1992-97

16. Change in public assets and liabilities, 1992-97

17. Changes in net worth and changes in liabilities, 1992-97

18. Change in public assets and liabilities, 1997-2002

19. Changes in govt liabilities and net worth, 1997-2002

20. Growth forecast and budget balance

21. 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

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