Setting up fiscal councils is another of the buzzwords post this crisis. But what are these and which countries have them? What have been the experiences?
The term Fiscal Council is generally used to describe an institution, funded by government, which provides public advice on fiscal issues. Here we will restrict the term to include only institutions that provide macroeconomic advice on the likely course of national budget deficits, but these same institutions may or may not also provide detailed microeconomic costing of the budgetary impact of particular projects or proposals (as is the case of the CBO in the US, for example).
These institutions are often described as ‘independent’. The degree and type of independence from, in particular, the Finance Ministry of a country varies across countries. They have begun to interest macroeconomists as a possible antidote to deficit bias: the tendency for government debt as a proportion of GDP to rise over time that has been observed in the OECD area as a whole. A few countries have had institutions for many decades that can be classed as Fiscal Councils, and while in some cases those countries do appear to suffer less from deficit bias (e.g. the Netherlands), in other cases problems remain (e.g. the US).
As yet there is no international network of Fiscal Councils, although the first conference bringing representatives from most of these councils together was held in Budapest in March 2010. This page contains links to the web pages of these Fiscal Councils, and also lists some of the academic work which has proposed and analysed such bodies. There is also a brief ‘question and answer’ section for those who do not have the time to read any of this literature.
Following countries have fiscal councils:
- United Kingdom
- United States
Here are some interesting Q & As:
Why might Fiscal Councils reduce deficit bias?
- By making fiscal positions more transparent, they may prevent governments deliberately concealing the extent of future deficits implied by current policies, or prevent governments being overoptimistic about their finances. The public may have insufficient information to differentiate between governments that are more efficient at managing spending, and those that pretend to be in order to win votes through spending increases or tax breaks. A Fiscal council could help provide that information.
- Because governments in a democracy may not be re-elected, there may be an incentive for them to discount the future heavily. In particular, by raising debt, they may stifle the spending plans of the opposition. If political parties differed over the size of the state, and if raising spending or cutting taxes was easier than the opposite, then raising debt might be the most effective way of achieving political aims.
- In the previous cases, if the public had full information and could discipline governments, deficit bias would not arise. An alternative reason for deficit bias is that the public may be selfish, in the sense that they attempt to exploit future generations, or they may be unable to resist immediate temptations. A Fiscal Council could attempt to apply political pressure on behalf of future generations, or provide moral pressure to discount the future less heavily. They may also prevent politicians pandering to these tendencies.
- Fiscal Councils may reduce the ‘common pool problem’ (see below). They can provide a coordination device that forces individual spending ministers to recognise the overall budget constraint: to ‘internalise the common pool externality’.
One of the motives for setting up a Fiscal Council may be a concern that governments are inclined to make overoptimistic projections of the public accounts (see Jonung and Larch (2006) for example). However not all Fiscal Councils prepare their own forecasts (e.g. Sweden). Equally, presentation of an independent projection for public deficits and debt is not a guarantee that governments will observe fiscal discipline. (The example of the United States under George W. Bush perhaps.) Variation here may reflect different institutional contexts in which fiscal projections are made: for example, are the macroeconomic forecasts used by a government produced by institutions with a reputation to protect, or are they the property of the government itself.
Fiscal Demand Management
There is a potential tension between using fiscal policy as a tool of demand management, and avoiding deficit bias. It may be politically convenient to expand fiscal policy in a downturn, but ignore the possibility of contraction in a boom. In an economy operating within a floating exchange rate regime, the question arises whether monetary policy should be entirely responsible for demand management (see Kirsanova, Leith and Wren-Lewis, 2009). Even in this case, however, if interest rates hit a zero lower bound, there is general agreement that fiscal expansion can and should play a role in supporting output. For countries operating under fixed exchange rates, or in a monetary union, there may be a more general case for using discretionary countercyclical fiscal policy.
In this context, a Fiscal Council may have an important role in ensuring that any demand stabilisation role for fiscal policy does not take place at the expense of a longer term prudent debt policy. The existence of a Fiscal Council could in this context make discretionary countercyclical policy easier for governments to undertake. In 2009 the Swedish Fiscal Council suggested additional fiscal expansion beyond that proposed by the government. A Fiscal Council could help overcome time inconsistency issues involved in countercyclical policy that are familiar from the monetary policy literature.
Very useful. There are some interesting papers as well.