considerations for designing a fiscal consolidation strategy
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Considerations for designing a fiscal consolidation strategy
Douglas SutherlandOECD Economics Department
20 June 2011“Fiscal consolidation, policy framework and governance” Policy Workshop IMAD, Ljubljana
• The starting point– What consolidation is already underway
• The end point– Fiscal gaps
• How to get there– Past experience and general principles
2
Third wave of large deficits in OECD
3
-10
-8
-6
-4
-2
0
2
4
6
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
Deficits% of GDP
0
20
40
60
80
100
120
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
% of GDP
Gross financial liabilities
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
4
0
50
100
150
200
250
0
50
100
150
200
250 2007 2011
Spending and revenues have reached a plateau?
5
0
10
20
30
40
50
60
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
Revenues% of GDP
0
10
20
30
40
50
60
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
Spending%of GDP
Large consolidations already underway
OECD Economic Outlook 2011
6
0
2
4
6
8
10
12
14
0
2
4
6
8
10
12
14
CHE
NZL
DNK
FIN
SWE
DEU
BEL
HUN
CAN
AUT
LUX
USA
KOR
JPN
SVN
ISR
NLD
FRA
ITA
AUS
GBR ES
TSV
KPO
LCZ
EIR
LES
PPR
TIS
LG
RC
Tightening between trough and 2012
% of GDP
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
7
Consolidations and growth
Growth before and after fiscal consolidation, based on different definitionsBottom panels when consolidation succeeds in stabilising debt at time t +1 or +3
8
-.02
0.0
2.0
4.0
6
-5 0 5time
Trough highlow
-.02
0.0
2.0
4.0
6
-5 0 5time
Sharp highlow
-.02
0.0
2.0
4.0
6
-5 0 5time
Gradual highlow
-.02
0.0
2.0
4.0
6
-5 0 5time
Sharp + 1 highlow
-.02
0.0
2.0
4.0
6
-5 0 5time
Sharp + 3 highlow
-.02
0.0
2.0
4.0
6
-5 0 5time
Gradual + 3 highlow
Expansionary contractions
Finland – 3 episodes of “expansionary fiscal contractions” 9
-4
-2
0
2
4
6
8
1980 1985 1990 1995 2000 2005 2010
Adjusted Primary Balance
10
20
30
40
50
60
70
1980 1985 1990 1995 2000 2005 2010
Gross Debt
40
45
50
55
1980 1985 1990 1995 2000 2005 2010
Underlying total revenues
40
45
50
55
1980 1985 1990 1995 2000 2005 2010
Underlying spending less interest payments
-.12
-.08
-.04
.00
.04
.08
1980 1985 1990 1995 2000 2005 2010
Real GDP growth
80
100
120
140
160
180
1980 1985 1990 1995 2000 2005 2010
Competitiveness indicator
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
10
Other spending pressures
• Demographic and other pressures on public spending
– Pensions
– Health and long-term care
– Contingent liabilities
11
Fiscal gaps
Simple model structure 12
Population
Budget
Other spending
Demographic spending
GDP
Revenues
Debt Interest
Baseline simulations
13
0
1
2
3
4
5
6
7
8
9
0
1
2
3
4
5
6
7
8
9
KOR
SWE
CH
E
LUX
ITA
DN
K
AUS
PRT
ESP
HU
N
CZE
GR
C
BEL
ND
L
FIN
DEU SV
K
AUT
CAN PO
L
FRA
IRL
NZL
GBR USA JPN
75 50 25 2007
Adding spending pressures
Note: Greece is pre-retirement reform
14
-2
0
2
4
6
8
10
12
14
-2
0
2
4
6
8
10
12
14SW
E
DN
K
ITA
AUS
POL
HU
N
PRT
CH
E
FIN
CZE
AUT
CAN FR
A
DEU
KOR
ND
L
BEL
GBR IR
L
LUX
ESP
USA NZL
JPN
GR
C
Baseline Pension Low health High health
Sensitivity analysis
• Costs of delay or stalled consolidation
• Fiscal shocks and contingent liabilities
• Risk premia
• Higher productivity
• Delayed retirement
15
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.
16
Large consolidations
Developments before and after the start of large consolidations, based on trough-to-peak of underlying primary balance
17
-.02
0.0
2.0
4.0
6
-5 0 5time
Real GDP growth
highlow
-4-2
02
4
-5 0 5time
Underlying primary balance
highlow20
4060
80
-5 0 5time
Gross debthighlow
3035
4045
5055
-5 0 5time
Underlying revenuehighlow
3035
4045
5055
-5 0 5time
Underlying spending (ex int)
highlow-2
-10
12
3
-5 0 5time
Spread
highlow
Challenges
• Sustained effort needed
– Enhance efficiency to support long-term growth
• More efficient distributional instruments
• Greater spending efficiency
• Less-distortionary taxation/user fees
18
Better distributional policies
Milligan and Wise (2011) 19
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
ITA ESP BEL CAN FRA DEU NLD SWE
Age 45 Age 64Proportion of men collecting disability benefits
More efficient spending
Joumard et al (2011) 20
Less distortionary taxation
21
0
0.5
1
1.5
2
2.5
3
3.5
0
0.5
1
1.5
2
2.5
3
3.5Un
ited
King
dom
Unite
d St
ates
Cana
daIs
rael
Fran
ceJa
pan
New
Zeal
and
Icel
and
Aust
ralia
Denm
ark
Pola
ndKo
rea
Swed
enIre
land
Spai
nPo
rtuga
lM
edia
nIta
lyCh
ileNe
ther
land
sFi
nlan
dG
erm
any
Slov
enia
Belg
ium
Slov
ak R
epub
licNo
rway
Hung
ary
Aust
riaTu
rkey
Mex
icoG
reec
eCz
ech
Repu
blic
Switz
erla
ndLu
xem
bour
g
2008% of GDP
Recurrent tax revenues from immovable property
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)22
Wider fiscal framework
• Good budgetary practices
• Fiscal rules
• Other fiscal institutions
23
Thank you
Douglas Sutherland@oecd.org
24
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