Comparing Fiscal Councils to Central banks

One often repeated suggestion is to have independent fiscal councils like independent central banks. Latter have been very good in forming credible mon pol and delivering low inflation most of the times. Similar could be done for fiscal policy which has so far been highly discretionary, time inconsistent, elections dependent etc. The same ills were seen for mon pol earlier which was turned around by central banks. This could be done for fiscal policy as well with delegation to a fiscal council which is like a central bank for fiscal policy.

That simple!

Not really says Simon Wren-Lewis. He points how fiscal policy is far more complicated and fiscal councils can never be as effective as central banks.

Comparing monetary and fiscal policy delegation is useful, if only because it shows in what ways an over simplified equating of the two may be misleading. Take for example the reason why we might want to delegate policy, or policy advice, to an independent body in the first place. Section 2 argued that explanations based on time inconsistency, so popular for monetary policy, do not carry over in a simple way to fiscal policy. Deficit bias may have rather different causes from inflation bias, as Section 3 discussed.  

The most obvious difference between monetary and fiscal policy delegation in practice is that the former involves the delegation of decisions, whereas the latter involves the delegation of advice and evaluation. The normal explanation for this is that tax and spending decisions involve redistributions of income and resources that are inherently political. However, interest rate decisions also involve significant redistributions, and are also politically sensitive. We discussed in detail two alternative reasons for this difference in the form of delegation. The first is that it could reflect a much greater importance of informational problems is explaining deficit bias compared to inflation bias. The second was that there was much less consensus about the objectives of long term debt policy compared to monetary policy.

Section 4 suggested that the benchmark theory which implied that debt should follow a random‐walk in steady‐state was not an adequate basis for policy in this area. However, there was little research on what alternatives might imply. This lack of knowledge, let alone consensus, makes  the delegation of decisions in this area unwise, but it increases the usefulness of the delegation of advice. A Fiscal Council can not only stimulate research directly, but it can also play an important role in evaluating research and avoiding unhelpful politicisation. This point seems particularly relevant to the Fiscal Council recently established in the UK.  

The example of UK Fiscal Council is discussed as well

The UK Fiscal Council is primarily charged with producing the official forecast on which budgetary decisions are based. It is unclear whether it can do this while retaining its independence. However over-optimism in the production of forecasts is only one potential reason for deficit bias, and it seems unlikely that it will be the only factor for the UK in the future. It would therefore seem sensible to allow Fiscal Councils in general to comment on what appropriate intermediate targets for policy should be (as some already do), particularly as this may enhance their perceived credibility and independence.   

Xavier Debru of IMF argues the same point as well:

Despite growing interest among policymakers, there is no theory of independent fiscal institutions. The emerging literature on “fiscal councils” typically makes informal parallels with the theory of central bank independence, but a very simple formal example shows that such a shortcut is flawed. The paper then illustrates key features of a model of  independent fiscal agencies, and in particular the need (1) to incorporate the intrinsically political nature of fiscal policy—which precludes credible delegation of instruments to unelected decisionmakers—and (2) to focus on characterizing “commitment technologies” likely to credibly increase fiscal discipline. 

He further says it can be possible but requires many changes:

1 The delegation of fiscal policy prerogatives to unelected officials is unworkable from a positive perspective, reinforcing the normative argument against fiscal delegation emanating from Alesina and Tabellini (2007). The model indeed illustrates that the very decision to delegate macro-relevant dimensions of fiscal policy—such as the level of the deficit, as suggested by Wyplosz (2005)—simply violates participation constraints of elected  decisionmakers. 

2. An independent fiscal agency is more likely to credibly enhance fiscal discipline if a broad mandate allows it to address the various manifestations of the deficit bias (from creative accounting to masking policy slippages or biasing revenue forecasts). This includes having the discretion to make normative assessments of the fiscal stance—albeit within the boundaries of elected politician’s own ex-ante commitments—in the light of cyclical conditions, public debt dynamics, and risks to public sector’s long-term solvency. 

3. The agency’s effectiveness is likely to be greater if it receives specific instruments to trigger a public debate where elected officials would have to publicly explain slippages (with respect to ex-ante targets) deemed inappropriate by the agency. By becoming a reliable source on the overall quality of fiscal policy, the agency can help voters identify ex-post deviations related to “bad policies” (as opposed to “bad luck”) and hold policymakers accountable. This is a task that rules-based fiscal frameworks—bound to remain simple to be operational—cannot by themselves deliver. Indeed, mere deviations from preset benchmarks do not always signal policy mistakes. 

4. As politicians may be reluctant to bear the short-term costs of deviations from ex-ante commitments, an effective fiscal agency ideally requires a degree of political independence enshrined in primary legislation (Constitutional or framework law) and guaranteed by ringfenced, multi-year budget appropriations or rules-based extra-budgetary financing (e.g. through a fixed transfer from the central bank) commensurate with the agency’s tasks.

Hmmm.

The literature on evolution of central banks shows that politicians basically struggled to credibly tell people that they would keep inflation in control and not print money. They needed an independent agency to tell public that their intentions are credible. Infact this delegation was not easy for the govt to give but had to. The things differ for fiscal policy as there are many more complications. Collecting taxes and govt spending involves the role of govt and cannot be delegated like mon pol is given to central bank.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.


%d bloggers like this: