The aim of this study is to analyze the Swiss debt brake as a model for controlling public finances and achieving more effective fiscal policies. Furthermore this study thus strives to contribute to the evolution of fiscal policy. While the benefits to the economy via more effective fiscal policy are straightforward, better fiscal performance is not only a matter of economics and economic welfare: ensuring all citizens’ trust and belief in public finance forms a major part of democracy (and indeed of every political system). The debate over effective fiscal policies should not neglect the way in which citizens consider sustainable fiscal policy to be a central issue for future generations and a general question of responsible government and legitimacy.
Before the 2015 parliamentary elections in the United Kingdom in 2015, the British Labour Party made fiscally responsible behavior its top priority in the election campaign. The Budget Responsibility Lock, as the fiscal plan is called in the Labour manifesto, puts a premium on the national finances by making the plan the basis of all proposed campaign plans. The commitment to sound public finances is on the cover of the manifesto, and Ed Miliband, leader of the Labour Party at the time, said his party was the “party of fiscal responsibility.” The party pledges to bind its policies to fiscally prudent behavior and to achieving deficit reduction every year. This focus on solid public finances is indicative of the heightened importance of fiscal responsibility in politics and society. Not only in Britain, but also in the majority of countries, both politicians and the public have realized the relevance of sustainable fiscal policy. But how can those in power materialize their electoral promises or make efforts to assert control of public finances?
List of Contents
1. Introduction
2. Fiscal institutions and their effects on fiscal performance
Fiscal institutions’ background and motivation
Fiscal transparency, fiscal councils, and fiscal rules as the three main ingredients of public financial management
The role and modalities of fiscal rules
Fiscal rules and their effects and fiscal outcome
Ensuring the effectiveness of fiscal rules: A question of institutional environment
3. Political economy of fiscal deficits
Why fiscal planners must be political economists
Preference heterogeneity between policymakers and voters
Heterogeneity of interests across politicians
Heterogeneity of interests across social groups or regions
Smart reforms of the budget process as an instrument against the common pool problem
Two forms of fiscal governance: The delegation and contracts approaches
4. Swiss debt brake as a case study for analyzing the effect of political context on the
performance of fiscal rules
Background and rationale of the introduction of the Swiss debt brake
Deterioration of public debt levels across all federal levels
The institutional context of the debt brake
Political culture: Fiscal conservatism as a strong norm in Swiss society
Structural reforms as a means of tackling the procyclical stance of federal fiscal policy
Characteristics and optimization of the Swiss budget process
Characteristics of the Swiss debt brake as a type of fiscal rule
The operation of the mechanism
Enforcement: The functioning and importance of the compensation account
Effect and relative success of the fiscal rule since its introduction
Reforms of the budget process resulting from the debt brake
5. The effect of political context on the performance of the Swiss debt brake
The unique characteristics of the Swiss institutional system and their influence on public spending
Political environment
Fiscal federalism
Direct democratic elements
Primacy of automatic stabilizers
Made in Switzerland: Political context and the Swiss debt brake
6. Conclusion
Abstract
English
The debt containment rule adopted in Switzerland in 2003, called the debt brake, is a Swiss made fiscal rule. The Swiss debt brake has been very successful in reducing Switzerland’s federal public debt levels, thus leading the federal budget on a sustainable path. The debt brake as a model for sustainable fiscal policy, however, must be viewed in light of Switzerland’s specific political context and its unique institutions that support the Swiss fiscal framework. The most notable political factors include a general culture of fiscal conservatism, which also becomes evident with the constraining elements of government expenditure at the cantonal and municipal level, and a strong parliamentary majority for reining in the growth of federal government expenditure since the 1990s. The debt brake is the culmination of previous efforts to constrain public spending and its design is a good reflection of the policymakers’ shared preference for the primacy of automatic stabilizers over discretionary fiscal policy. The constrains of direct democracy on public spending on Switzerland’s federal, cantonal, and municipal government level does not singularly limit spending, but profits from the existence of a federal structure with strong fiscal autonomy and fiscal referendums in place.
Abstract
German/Deutsch/Allemand/Tedesco
Die Schweizer Schuldenbremse, eingeführt im Jahr 2003, ist das Kind von deutlichen Schweizer Einflüssen; im Gegensatz beispielsweise zu den supranationalen Fiskalregeln des Europäischen Stabilitätspakts. Die Bestimmungen der Fiskalregel führten zu einer nachhaltigen Fiskalpolitik. Die Schuldenbremse als Erfolgsmodell für Fiskalregeln bedarf allerdings eines genauen Verständnisses seiner landesspezifischen Erfolgsgrundlagen. Als die wesentlichsten politischen Faktoren gelten: eine konservative Kultur hinsichtlich staatlicher Ausgaben, welche sich auf kantonaler und kommunaler Ebene institutionalisiert hat, und eine seit den neunziger Jahren vorherrschende starke parlamentarische Mehrheit zur Eindämmung der Ausgaben des Bundeshaushalts. Die Schuldenbremse ist das letzte Element einer schrittweisen Verstärkung der Mittel zur Schuldenbegrenzung. Die sehr restriktive Fiskalregel funktionierte auch deshalb, weil seine Ausgestaltung der passende Ausdruck des politischen Willens einer Präferenz für das Primat von automatischen Stabilisatoren, verbunden mit einer Abkehr der aktiven Fiskalpolitik, ist. Der direkten Demokratie wird in der Mehrzahl der Studien ein zu hoher mäßigender Einfluss auf die Staatsausgaben auf föderaler, kantonaler und Gemeindeebene zugesprochen, da dieses institutionelle Mittel nur dank anderer Elemente wie einer starken Ausprägung von Finanzautonomie der Kantone und Gemeinden diese Wirkung ausüben kann.
Acknowledgements
I would like to express my deep gratitude to my master thesis advisors, Professor Dr. Alexander Kemnitz and PhD student Patrick Zwerschke. I am thankful for their academic and personal support during the process of writing my master thesis.
While conducting studies on the topic of my thesis, I was able to speak to people involved with the legislative and executive branches of the government as well as academia. First, I am grateful for the opportunity to speak with Leo Müller, President of the Finanzkommission of the CVP (Christian Democratic People’s Party of Switzerland) and member of the Swiss National Council (Nationalrat). I would also like to thank Adrian Martínez, economist in the fiscal-policy section of the Swiss Ministry of Finance (Eidgenössisches Finanzministerium), for his expert advice and for sharing his insights on Swiss fiscal policy, particularly on the debt brake. Professor Gebhard Kirchgässner of the University of St. Gallen has published several influential scientific articles on Swiss fiscal policy and has kindly shared his wide knowledge about this subject with me. Finally, I would like to thank Dr. Frank Bodmer, who was formerly employed at the Eidgenössisches Finanzministerium and who published several scientific investigations on the Swiss debt brake, for a fruitful discussion on the most important aspects of the functioning of the Swiss debt brake.
List of Illustrations
Figure 1: Gross public debt for the Eurozone, UK, and US, 1970-2004
Figure 2: General government net lending for the Euro area and OECD countries (1970-2010)
Figure 3: EU countries: Precrisis fiscal performance and national fiscal rules
Figure 4: Budget planning and the use of medium-term budget frameworks (MTBFs). Average three-year-ahead forecast error
Figure 5: Cyclically adjusted budget (CAB) balance, CHF million (1980-2012)
Figure 6: Budget deficits/surpluses and business cycles, 1970-2000. The red lines indicate real GDP growth; the blue lines show the balance of the federal budget (million CHF)
Figure 7: Switzerland: Debt-to-GDP ratio of the federal government, cantons, and communes, 1980-1999
Figure 8: Switzerland: International comparison of general government debt ratio (in percentage of GDP)
Figure 9: “Iceberg” metaphor for the Swiss debt brake as the most visible part of the much larger Swiss fiscal framework
Figure 10: Correlation between the fiscal stance and the output gap
Figure 11: Ideal development of public expenditure under the provisions of the debt brake
Figure 12: Switzerland, gross federal debt (1980-2011). LHS: left-hand side; RHS: right-hand side. Gross federal debt levels started to decline in 2005, two years after the introduction of the debt brake due to an economic recession
Figure 13: Fiscal impulse of the federation and social insurances (1951-2007). Vertical axis left side: fiscal impulse as a percentage of GDP; right side: real GDP growth (in percentage points)
Figure 14: Investment spending (1980-2011). The cyclical nature of investment spending stopped and steadied under the debt brake
Figure 15: Decentralization across the world (98 countries - average 1972-2000); subnational and expenditure shares
Figure 16: Swiss parties and their number of votes won (as a percentage of the total amount of seats) in the elections for the Swiss federal parliament (Nationalrat)
List of abbreviations
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1. Introduction
Before the 2015 parliamentary elections in the United Kingdom (UK) in 2015, the British Labour Party made fiscally responsible behavior its top priority in the election campaign. The Budget Responsibility Lock, as the fiscal plan is called in the Labour manifesto, puts a premium on the national finances by making the plan the basis of all proposed campaign plans. The commitment to sound public finances is on the cover of the manifesto, and Ed Miliband, leader of the Labour Party at the time, said his party was the “party of fiscal responsibility.”[1] The party pledges to bind its policies to fiscally prudent behavior and to achieving deficit reduction every year.[2] This focus on solid public finances is indicative of the heightened importance of fiscal responsibility in politics and society. Not only in Britain, but also in the majority of countries, both politicians and the public have realized the relevance of sustainable fiscal policy. But how can those in power materialize their electoral promises or make efforts to assert control of public finances? This is the leading question behind this study.
In Switzerland, a fiscal rule called the Swiss debt brake has largely been responsible for a strong reduction of federal public debt since its introduction in 2003. The fiscal rule, which requires expenditures to equal revenue, has gained considerable attention among policymakers and international organizations such as the Organisation for Economic Co-operation and Development (OECD) and the International Monetary Fund (IMF) because if its success. For this reason, a better understanding of why and how this fiscal rule was able to put public finances in Switzerland on a sustainable path could potentially help other countries to improve their unique fiscal frameworks and budgetary processes. This study will thus analyze the Swiss debt brake as a model for controlling public finances and achieving more effective fiscal policies.
The first chapter of this study will introduce the current state of thinking on fiscal institutions (such as fiscal rules) as well as technical aspects related to the improvement of public financial management. The discussion provides the necessary background for understanding the manner in which the design of fiscal institutions (such as the Swiss debt brake) may increase a country’s fiscal performance. The second chapter provides theoretical input for assessing how the Swiss debt brake was successful in changing the spending behavior of the political actors responsible for federal expenditure. Enhancing fiscal policy requires theoretical insights relating to political economy, since it is as much a political as an economic question.
Subsequently, the Swiss debt brake as a fiscal policy instrument will be studied regarding the motivation behind its introduction and the structural reforms following from compliance with its provisions. Thus, this chapter’s analysis will provide important explanations on the particular conditions that created the necessary political commitment to the rule, thereby contributing to the rule’s success. Lastly, Switzerland’s political context will be analyzed in order to determine how its institutions served to constrain public spending. Another reason for this case study is the absence of a good understanding of which Switzerland’s political factors made the rule function. This analysis also makes a general contribution to the assessment of institutions’ effects on public expenditures; the most relevant institutions for public spending in Switzerland include its strong federal structure, direct democracy, and a tradition of power sharing.
This study thus strives to contribute to the evolution of fiscal policy. While the benefits to the economy via more effective fiscal policy are straightforward, better fiscal performance is not only a matter of economics and economic welfare: ensuring all citizens’ trust and belief in public finance forms a major part of democracy (and indeed of every political system). The debate over effective fiscal policies should not neglect the way in which citizens consider sustainable fiscal policy to be a central issue for future generations and a general question of responsible government and legitimacy.
2. Fiscal institutions and their effects on fiscal performance
Fiscal institutions’ background and motivation
In the course of the last few decades, spurring public debt as a percentage of gross domestic product (GDP) has been a common concern for most advanced economies. As illustrated in figure 1, debt levels have accumulated from the late 1970s onward in most of Europe as well as in the United States of America (US). Pointing to the same trend, figure 2 demonstrates how governments since the 1970s have consistently run budget deficits. These numbers are a reflection of a phenomenon called deficit bias. Although countries have strengthened their fiscal frameworks and have increased their knowledge about fiscal policy, the quest for sustainable finances will remain a sensitive issue for the near future.[3] This has led many countries to launch structural reforms in an effort to achieve fiscal discipline and to reduce debt levels to a sustainable level; these efforts may be summarized as institutional budget reforms.
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Figure 1: Gross public debt for the Eurozone, UK, and US, 1970-2004. Wyplosz (2005): 65
It is important to note that fiscal discipline does not demand budgets to be balanced each year, but deficits do need to be matched by budget surpluses, which is why focusing on business cycles has proven to be beneficial. In addition, achieving a sustainable fiscal policy does not necessarily require lowering public debt in absolute terms: the imperative is to keep the development of public debt stable in relation to GDP. The growth of public debt must not be higher than GDP growth. The factors related to the proper implementation of fiscal institutions to reach the goal of solid fiscal finances will be the focus of this paper.
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Figure 2 General government net lending for the Euro area and OECD countries (1970—2010). Hagemann (2011): 77
Fiscal transparency, fiscal councils, and fiscal rules as the three main ingredients of public financial management
The management of a country’s public finances is an essential task of government. Fiscal policy is the means and primary tool by which governments can influence macroeconomic stability, growth, and income distribution. Due to the key importance of budgetary policy, numerous studies by international organizations such as the IMF and the OECD, as well as those conducted within academia, have investigated institutional budget reforms and best practices for achieving sustainable public finances.
The proper institutional arrangements that support fiscal policy may be summarized by the term public financial management (PFM). According to North, PFM is defined as:
“PFM is concerned with the laws, organizations, systems and procedures available to governments wanting to secure and use resources effectively, efficiently and transparently.”[4]
For example, fiscal sustainability as a key goal of fiscal policy will be strengthened if budget institutions are properly put in place.[5] PFM accordingly is of strong relevance, since it has a clear bearing on the effectiveness of fiscal policy. Specifically, researchers have identified three categories of institutional reforms of PFM: fiscal transparency, fiscal councils, and fiscal rules.[6] The transparency of fiscal accounts is strongly linked with effective fiscal policy; the requirements of fiscal transparency are “comprehensiveness, quality, and timeliness” in reports on public finances.[7] Put differently, public fiscal reports must be understandable, thus putting citizens in a position where they can hold the government accountable for fiscal policy. Furthermore, reports must be reliable and must not leave room for the manipulation of fiscal positions.[8]
Fiscal disclosure has improved in recent years, since countries have tried to implement a “set of internationally accepted standards for fiscal transparency.”[9] With good fiscal transparency in place, it is possible to strongly mitigate fiscal risk; because the financial crisis has revealed large gaps in fiscal transparency, however, standards and practices related to fiscal transparency have been refined in recent years.[10]
Second, various considerations of supporting mechanisms for fiscal policy have emphasized the importance of fiscal councils. As a result of the allegedly positive effects of such councils, Canada, Ireland, Portugal, Sweden, and the UK have introduced such councils in the past few years.[11] Both the growing number and the prominence of fiscal councils have stemmed from their endorsement by international organizations such as the IMF and the OECD as well as the positive effects illustrated by existing fiscal councils.[12] It should be clear, however, that as with fiscal institutions in general, the role and modalities of fiscal councils have to be adapted to a country’s unique political and economic configurations.[13] By focusing on the Swiss debt brake, this paper will provide further analytical backing for this specific argument. Thus, the various fiscal councils in existence have different mandates, rights, and functions.[14]
Fiscal councils can potentially have a strong role to play in enforcing fiscal rules.[15] Because they are independent and publicly funded, they can inform public debates in a neutral manner; their analysis of fiscal developments can facilitate budget preparation and can also prevent politicians from making unrealistic promises by providing input on the budgetary effects of proposed spending programs.[16]
Before introducing the third component—fiscal rules—it should be stressed that all three sets of institutional reforms are linked. In other words, the success and potential of fiscal rules do not work in isolation and will depend to a large extent on the degree of fiscal transparency and the configuration of fiscal councils.[17] The analysis of the Swiss debt brake and the Swiss fiscal framework as a whole in the following chapters will also serve to highlight this central argument. One should also not expect that fiscal rules will miraculously put public finances on a sustainable path.[18] Similarly, the effectiveness of fiscal rules will be enhanced if they operate within a framework. A strong argument in favor of framework-based rules is that they are more aligned with the particular economic conditions and political culture of a country.[19] We should bear in mind that more variance is to be found in fiscal rules than in monetary or exchangerate rules; fiscal rules are also more complex.
Fiscal rules constrain fiscal policy because they track the numerical development of a certain fiscal indicator and require political decisions in case inconsistent fiscal policies are enacted. Fiscal rules may be grouped into four different categories: expenditure rules, budget-balancing rules, debt rules, and revenue rules; the rules are classified according to the fiscal indicators or target variables they use. The first category, expenditure rules, are also called “ceilings” because they predetermine a given level of government expenditure before budget preparations begin. The second type (budgetbalancing rules) limit government spending by capping spending to the amount of revenues; those rules may require the budget to be balanced over a business cycle, meaning that budget deficits must be subsequently matched by surpluses.[20] Third, debt rules are limits that apply to the amount of government debt; these limits may be set in nominal terms or as a ratio to GDP.
The role and modalities of fiscal rules
Fiscal rules and their effects and fiscal outcome
In most developed countries, fiscal rules have been established against the background of such rules’ potential role in reaping the benefits of solid finances; it appears that EU countries with national fiscal rules in place have generally achieved better fiscal performance than those without. Graph 3 shows the average structural balance of 27 EU countries over the time period of 2002 to 2007. The effect of these rules on sound fiscal outcomes can yield positive results through macroeconomic stability, fiscal responsibility, and overall policy credibility.[21] Macroeconomic stability is largely strengthened through the following channels. Fiscal rules that increase fiscal discipline can provide stability, because the very notion of fiscal sustainability implies that fiscal policies may be maintained indefinitely; unsustainable fiscal policy, in contrast, will have negative implications on the economy by creating an atmosphere of uncertainty. This occurs because businesses and consumers will ultimately expect the government to introduce changes to fiscal policy.[22] Alongside other negative effects, this type of situation might lead companies to withhold investments, as occurred in 2013, when the US government experienced a deadlock in negotiations on a debt-reduction plan.[23]
illustration not visible in this excerpt
Figure 3: EU countries: Precrisis fiscal performance and national fiscal rules. IMF (2013): 43
Fiscal rules may also serve as a deterrent of procyclical fiscal policy, thereby weakening fluctuations of the business cycle; such rules may then support a key element of fiscal policy, which is the stabilization of production and employment. Although most governments understand the need for countercyclical fiscal policy, actual practice has shown that most countries will increase their government spending when more revenue becomes available during economic upswings. Fiscal rules may therefore lack the required political commitment to correct the imbalance that was described above as deficit bias. Fiscal expenditure rules, for example, leave less room for political bickeringjbecause they clearly set a ceiling for spending. Violation of the expenditure rule is also made more difficult, since the rule’s operations are transparent.[24]
It is equally important to emphasize the correlation between persistent fiscal deficits and high debt (on one side) and economic growth on the other. The main result of an empirical study by Rogoff and Reinhart (“Growth in a Time of Debt,” published in 2010) was that countries with levels of public debt over roughly 90 percent of GDP will experience significantly lower levels of economic growth.[25] Their study served as a strong reference in the public debate over public finances and elevated public debt levels at the time of the paper’s publication. For example, advocates of austerity measures during the Eurozone debt crisis used the Rogoff/Reinhart investigation as part of their scientific evidence in favor of austerity.[26] Fiscal rules, when they are effective, create fiscal space, thus allowing for fiscal policy responses to economic crises, natural disasters, or other obligations.[27] If countries that lack fiscal buffers spend money in response to critical situations, the chances will be even higher that fiscal sustainability or the stability of the economy will be compromised.[28]
Another significant advantage of fiscal rules is that they can lead to lower borrowing costs for public debt on the capital market. This financial gain is materialized indirectly through fiscal responsibility, as perceived by financial actors.[29] One reason many emerging economies have introduced fiscal rules is because they want to reinforce the image that they are fiscally disciplined, which will then allow them to profit from open capital markets.
Ensuring the effectiveness of fiscal rules; A question of institutional environment
This section discusses fiscal rules and the conditions related to their effects on fiscal performance. As was briefly noted earlier, the specific contributions of fiscal rules and fiscal institutions in general on fiscal outcomes are difficult to assess.[30] Stated another way, causality between good fiscal rules and the effects of those rules is difficult to ascertain. Although data might indicate correlations, empirical studies may be flawed due to the “endogeneity” problem. In other words, the fiscal rules themselves might only be expressions of the already-established preference and commitment to sound public finances that are shared by voters and politicians alike.[31] Indeed, in cases where fiscal discipline is maintained without restraints by rules, fiscal rules might be redundant; alternatively, fiscal rules will lose their strength when governments do not provide proper enforcement and commitment over a medium time frame.[32]
Despite the reservations enumerated above, it is possible to make a few valid points about the design and performance of fiscal rules. As a general rule, fiscal rules fare better when governments maintain good formulation and good operation of the rules. Fiscal rules must first be applied before the budget is approved; apart from this commonality, fiscal rules feature different characteristics. Allen Schick, professor and leading scholar in the field of budget policy and budget processes, has identified five criteria regarding the improvement and evaluation of fiscal rules:
i. The time frame should be lengthened from a single year to the medium term;
ii. Baseline projections (or forward estimates) should be created of future budgetary conditions;
iii. Estimates should be made of the impact of policy changes on future budgets;
iv. (Procedures should be enacted for monitoring budget out-turns and for taking corrective action when necessary; and)
v. Enforcement mechanisms should be put in place to prevent opportunistic politicians from breaching the rules.[33]
First, the performance of fiscal rules will be jeopardized if budget-making is constrained by a short-term focus (annual or biennial), since this can allow governments to evade fiscal pressures by shifting expenditures to the following fiscal years or by gaining short-lived increases in government income. Governments can avoid this short-term focus by extending the time frame, for example by applying a medium-term expenditure framework (MTEF). This framework imposes limits on expenditures for each fiscal year during a three- to five-year time frame.
Second, fiscal rules’ performance will be strengthened by using medium-term budget frameworks (MTBF); these enhance fiscal-policy planning in several ways, one of which is to provide an improved perspective of future budgetary conditions (ii). The path of public expenditure will be more clearly delineated under such frameworks, thus allowing for more accurate projections of fiscal developments. Baseline projections show how the budget develops when current spending policies are maintained when operating under certain demographic, macroeconomic, microeconomic, and other assumptions, which allows governments to measure the impact of different policy proposals on the budget balance. Governments can also use these projections to trace future fiscal pressures, including any significant changes in demographics, such as aging (iii). MTBFs can thus be seen as a support element for fiscal rules.[34]
In addition, a 2013 study by Harris et al. provided evidence that countries with strong and binding MTBFs, as is the case with Sweden and the UK, are more accurate in predicting expenditure and revenue levels.[35] Figure 4 provides an illustration of the differences in forecasting errors between EU countries; the numbers in the graph demonstrate how forecasting expenditures and revenue improve due to the existence of binding MTBFs. EU member countries with indicative (or no) MTBFs, in contrast, generally show more forecasting errors. It would appear to be good practice to make long-term fiscal projections of ten years or more; in addition, reports on fiscal projections should be announced every year.[36]
illustration not visible in this excerpt
Figure 4: Budget planning and the use of medium-term budget frameworks (MTBFs). Average three- year-ahead forecast error.
IMF (2013): 38
The intelligent design of fiscal rules is essential with enforcement mechanisms; the general advice is that fiscal constraints must dovetail with the prevailing political culture.[37] For example, fiscal rules that are formulated as hard constraints will have no value if they ignore political realities. This argument seems to favor country-specific rules over supranational rules. As an external constraint on fiscal policy, for example, the EU’s Stability and Growth Pact (SGP) is a uniform rule for all EU member states: all member states must comply with its specifications regardless of their political commitment and political culture. The performance of supranational rules can be improved, however, if they are combined with national fiscal rules that are more binding.[38] Empirical evidence on the fiscal performance of EU countries with additional fiscal rules in place supports this argument. Figure 3 demonstrates the difference in average structural balance from 2002-2007.
Finally, it is important to consider the question of which fiscal aggregate should be targeted. As was discussed earlier, fiscal rules may be categorized into four types; among these four types, choosing expenditure rules is arguably the best option, because doing so has several advantages. First, expenditure rules are more credible.
Credibility comes from increased transparency, since the operation of the rules is easier to monitor and follow. Second, expenditure rules allow for improved verification. Third, it has been brought forward that expenditure rules correlate better with macroeconomic stabilization than deficit rules.; while deficit rules work procyclically in fiscal expansions and fiscal recessions, expenditure rules work countercyclically. Part of their explanation for this is that expenditure rules do not infringe on the operation of automatic stabilizers.[39] Fourth, Anderson and Sheppard (who were officials at the OECD at the time of their study’s publication) argue that spending rules are more effective in ensuring fiscal responsibility.[40] The crucial test of fiscal rules is whether or not they create budget surpluses in good economic conditions. A 2013 study by the IMF supports this argument; it concurs that fiscal constraints must be strong under favorable economic circumstances. The study adds that fiscal policy must have more flexibility in unfavorable economic circumstances. Because spending rules are less rigid in terms of deficits, such rules provide policymakers with more flexibility in terms of fiscal policy.[41]
3. Political economy of fiscal deficits
Why fiscal planners must be political economists
The preceding discussion on the design of fiscal institutions, with its special focus on fiscal rules, has highlighted several key issues related to the way in which well-designed fiscal institutions can lead to improved fiscal performance. In this sense, the analysis yielded several insights into the ways that political factors shape the effect of fiscal institutions. Yet these considerations took a somewhat technocratic approach by discussing institutional budgetary reforms without having a firm grasp of the underlying political realities. Public finance managers have become better about incorporating the necessary political elements in recent years. In order to provide a more comprehensive picture of the design of fiscal institutions, this chapter will present the most relevant theoretical concepts and arguments on the topic that have been put forth to date. It should be noted, however, that these theoretical ideas taken together do not represent one unified theory (which might be called the “political economy theory of fiscal deficits”); still, it is crucial to understand the theoretical arguments for the implementation of fiscal rules as a means to address each country’s unique fiscal problems.
A reasonable starting point for investigating the underlying causes of deficit bias is politicians’ propensity for spending public money. For this reason, electoral pressures are generally considered to be a major root cause of deficit spending, since one could argue that politicians will not resist the popular effects of government spending. Put simply, stimulating the economy brings votes. As researchers have moved ahead in examining this argumentation, however, they have shown that statement to be both vague and simplified. Theoretical classifications that narrow down the politico- institutional determinants of government budgets—as Marcela Eslava did in her survey study on “the political economy of fiscal deficits”—distinguish between three kinds of preference heterogeneities. Eslava makes the general point that preference heterogeneities lead to conflicts of interest. According to Eslava, preference heterogeneities can be classified in three different ways:
i. Preference heterogeneity between policymakers and voters,
ii. Heterogeneity of fiscal preferences across politicians, and
iii. Heterogeneity of fiscal preferences across social groups or regions[42]
Preference heterogeneity between policymakers and voters
A central element in the first grouping of theoretical models is the assumption of opportunism as a key driving force of politicians’ excessive use of public money. But transforming fiscal-policy measures into better chances of staying in office is only a feasible option as long as stimulus packages remain popular among the electorate: in other words, such transformations rest on the premise of “fiscal illusion.” According to this concept, voters favor current spending because voters underestimate the future costs of spending programs. This early theoretical concept has lost much of its explanatory power, however; one of its shortcomings is the assumption that the electorate does not learn the basic lesson of the implicit future costs of deficit spending nor of the short-lived nature of the engineered economic expansion.[43]
This assumption is also inconsistent with studies that have demonstrated that voters support conservative fiscal policies. In many cases, governments that embark on fiscal- adjustment programs will align with voters’ fiscal preferences. The majority of studies have suggested that office holders who choose to rein in deficits will be more likely to be rewarded at the polls.[44] Another factor that needs to be taken into account is that fiscal contraction need not stifle economic activity, which should have a positive effect on the public’s perception of fiscal adjustments.[45] Some have argued that when governments introduce structural reforms during periods of fiscal tightening they build the foundation for dynamic economic activity, thus increasing the popularity of these reforms among voters. The UK’s achievement of solid economic growth from 20132015 after implementing a fiscal-adjustment that started in 2010 is a good illustration of this point.[46]
[...]
[1] Buchsteiner (2015): 5
[2] The Labour Party (2015)
[3] See also: Wyplosz (2005): 64-65. In contrast with the evolution of monetary policy, Wyplosz is very negative on the state and performance of fiscal policy and fiscal rules in the year 2005. He regards it as “no surprise [...] that debts and deficits continue to flourish in many countries.”
[4] Allen, Hemming, Potter (2013b): 1
[5] Allen, Hemming, Potter (2013b)
[6] Hemming (2013c): 36
[7] IMF (2012): 3
[8] Ibid. 5
[9] IMF (2013): 39
[10] IMF (2012): 3
[11] Hagemann (2011): 76
[12] Hagemann (2011): 82
[13] Hemming (2013c)
[14] IMF (2013): 44
[15] Ibid.
[16] Frankel, Schreger (2012): 268-270
[17] Kopits, Symansky (1998): 1; Schick (2010) makes a similar argument on page 48 of his article, but puts more emphasis on political commitment and disciplined budget procedures. As will be shown in the chapter on the analysis of the Swiss fiscal framework, the Swiss debt brake serves as a neat example of a disciplined budget procedure. It has improved the Swiss fiscal framework decisively with regards to establishing a disciplined budget procedure.
[18] Kopits, Symansky (1998): 17
[19] Schick (2010): 44
[20] Wyplosz (2005): 69
[21] Kopits, Symansky (1998): 6
[22] European Central Bank (2009): 17
[23] New York Times (2014). The Article called “Uncertainty in Washington poses long list of economic perils” describes the negative effect of uncertain US fiscal policy on US businesses and economic growth. The Business Roundtable (a representation of the main executives of the nation’s biggest companies) is quoted as using their leverage to achieve stability in tax and fiscal policy.
[24] Anderson, Sheppard (2009): 20
[25] Rogoff, Reinhart (2010)
[26] In 2013, Jens Weidmann, president of the German Bundesbank, defended the need for fiscal consolidation in the European Union and argued against critics who raised doubts about the scientific value of the study by K. Rogoff and C. Reinhart. Source: http://www.zeit.de/wirtschaft/2013- 04/weidmann-rogoff-reinhart-studie
[27] Hemming (2013c): 32-33
[28] Marcel (2013): 10
[29] Hemming (2913c): 29-34
[30] Anderson, Sheppard (2009): 21
[31] Millar (1997): 18-19
[32] Anderson, Sheppard (2009): 21
[33] Schick (2003): 8-9
[34] Schick (2003): 8-9
[35] Harris et al. (2013): 145
[36] Anderson, Sheppard (2009): 8-10
[37] Schick (2010): 36-37
[38] Ibid. 43
[39] Anderson, Sheppard (2009): 20-21
[40] Ibid.
[41] IMF (2013): 41-44
[42] Eslava (2011): 646
[43] Ibid. 647
[44] Ibid. 650
[45] Ibid.; See also Alesina et al (1998) for a more extensive study. The authors studied episodes of fiscal adjustment in 19 countries from 1960-1995 and did not find general evidence for fiscal adjustments causing economic downturns.
[46] According to Eurostat, the country manifested economic growth rates in these years of 2.3, 2.9 and 2.3 per cent of GDP, respectively.
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Upload your own papers! Earn money and win an iPhone X. -
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Upload your own papers! Earn money and win an iPhone X. -
-
Upload your own papers! Earn money and win an iPhone X. -
-
Upload your own papers! Earn money and win an iPhone X. -
-
Upload your own papers! Earn money and win an iPhone X. -
-
Upload your own papers! Earn money and win an iPhone X. -
-
Upload your own papers! Earn money and win an iPhone X. -
-
Upload your own papers! Earn money and win an iPhone X. -
-
Upload your own papers! Earn money and win an iPhone X. -
-
Upload your own papers! Earn money and win an iPhone X. -
-
Upload your own papers! Earn money and win an iPhone X. -
-
Upload your own papers! Earn money and win an iPhone X. -
-
Upload your own papers! Earn money and win an iPhone X. -
-
Upload your own papers! Earn money and win an iPhone X.