International experience of

Independent Fiscal Institutions

José Luis Escrivá, Chair of the Network of European IFIs and President of the AIReF

Mexico, 11th of May 2017

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Biases towards inflation and public debt: two different paths

The Government bias towardsinflation has been addressed in thelast decades by giving CentralBanks more Independence in thedesign and instrumentation ofmonetary policy.

This has shifted the bias, from amonetary-based funding of publicdeficit towards a public-debt-basedapproach.

Resorting to an analogy: could IFIs contribute to neutralize the bias towards public debt?

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Public debt/GDP and inflationEA12, USA, Japan, Canada

Deflactor PIB (eje izdo) Deuda/PIB (eje dcha)GDP deflator (left axis) Debt/GDP (right axis)

Sources: European Commission, IMF and AIReF

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IFIs can make a relevant contribution albeit modest

The bias towards inflation and deficit has a well-grounded explanation, agreedupon by the academic literature: time inconsistency. Diverse theories help to explainwhy the decisions made in the present may be sub-optimal: Information problems Impatient electorate or impatient politicians Electoral competition

In the realm of monetary policy, the response has been to withdraw the decisionsfrom political discretion, transferring them to an entity independent from theGovernment and directed by technical criteria: Central Banks have competences related to the design of rules, and they dispose

of the instruments to carry them out

However, in democratic systems it is not possible to delegate the decisions aboutpublic revenue and spending. It cannot be attributed to a technical sphere, whichdoes not count neither with democratic legitimacy to set tax objectives (which levels,which rates…), decide spending policies or the concrete instrument to achieve suchpolicy goals. Fiscal policy has strong redistributive effects that prevent it from beingdelegable.

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How can IFIs contribute to contain the bias towards public debt?

They can provide analysis and data that conditions the decisions to be made, alsoinforming the decision-making process with technical criteria to help prevent thecauses of the bias, whether they were:

Common pool theory

Time inconsistency

How does this bias materialize? What responsibilities can be transferred to IFIs?

Optimistic forecasts Production/endorsement of projections

Discretionary fields due to lack of transparency

Objective analysis of the fiscal situation and prospects

Bias towards the short-term Medium-term approach and sustainability analysis

Reluctance to adhere to the rules Guardians to the rules. Increase in the reputational cost

Lack of internalization of the total costs of the decisions taken

Assessing policy options without pressures from lobby groups (costing)

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Two models for IFIs at the global level

“ANGLOSAXON” MODEL

IFIs predominate over the rules

Control of the Executive

Positive analysis

Costing

PBOs

Mandate: common features. But heterogeneity

Model/final setup: adapted to country- specificities (common principles)

EUROPEAN MODEL

Rules-based model

Control of the rules

Recommendations

IFIs are guardians to the rules

Institutional diversity

Macro projections: endorsement/production

Transparency/communication

Surveillance of the rules

National rules

EU rules

UE IFIs

Even though the reasons to establish an IFI have been well documented…

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For them to be effective, their institutional setup and their human resources are crucial

And there has been a global expansion of them, mostly after the crisis…

There are three main elements to be highlighted from the already broad international experience

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1. Independence

2. Mandate

3. Functional autonomy

Basic requirement for effectiveness to be accomplished

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IFIs must be able to provide an objective analysis, dissociated from anypolitical influence. This independence is particularly important when theIFI has competences that are directly linked to the budgetary process, orwhen the IFI can issue recommendations

Important aspects to bear in mind regarding the legal setup: IFI’s configuration: attached to the Parliament, to the Ministry, to the

Central Bank? The procedure to appoint its directive team, and the system for

internal decision-making: single-person direction vs councils

Besides adequate legal safeguards, the practice of the IFI is significantlystrengthened when the IFI follows the principles of transparency, publicityand accountability

1. Independence

What type of IFI? Is there any model that offers better guarantees?

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Whether an IFI is functionally attached is not very relevant. The diversity of modelsresponds to institutional tradition, type of responsibilities that they have been attributedand even the institutions that were already in place at the moment that the IFI was created.There are cases of success with very different setups: Parliamentary Budget Offices (PBOs): CBO Ministries: CPB, OBR Attached to Central Banks: CBR

1. Independence

More determinant factors are how the IFI’s directive team is organized and how thedecision-making process operates. Single-person chair vs collegiate? Although IFIs with collegiate decision-making bodies are more common, the most

successful cases feature a single-person direction. They resemble more the Researchor Studies Departments of Central Banks

Collegiate and plural bodies make sense when the decisions require making ajudgments or implicate issuing recommendations

As long as the IFI’s functions do not entail neither value judgements nor issuing recommendations, it is preferable to opt for a single-person

model

Impossible to attain without a procedure for appointment that were not partisan, particularly for “presidential” IFIs

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The OECD’s general principles constitute a good guideline

1. Independence

Most IFIs follow them, applying different systems for appointments In federal countries: appointments are made by the different levels of the Administration, business

chambers, research institutes, with a tendency to hire academics, part-time and paying allowances Predominant case: appointments made by the Government, after a proposal by the Ministries of

Economy/Public Finances Some cases: appointments made by the Parliament (reinforced majorities) after the proposal of the

Government or the President Portugal: appointment by the Council of Ministries, after the joint proposal of the Courts of Audits and

the Central Bank

Based on merit and independence from politicalaffiliation

Clear legislation: mandates, grounds for dismissal Term dissociated from the electoral cycle

Transparent procedure Proven competences Full-time and paid positions

The evolution towards selection procedure based on competence is missed

Irish PBO (under creation): has opened a competitive process

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1. Independence

2. Mandate

3. Functional autonomy

There are three main elements to be highlighted from the already broad international experience

2. Mandate

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Clear definition, adapted to the reality of each country

Specificities of the Spanish case

It must be the result of a reflection on each country’s rationale

The crisis had very destabilizing effects on public finances

Loss of credibility

Need for European funding

Institutional reasons

Spanish fiscal rules are more stringent than the EU ones

Decentralized State:

compliance at the regional level

AIReF’smandate: broad, covers all government levels

AIReF has one of the broadest mandates within the EU

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Fiscal policy planning

Stability Plan

Macroeconomic forecasts

Objectives of the Autonomous Regions

Follow-up of the budgets

Ex ante

Budgetary projections

Opinion on the Pension Revalorization Index

During the year

Initial budgets

Identification of risks

Implementation of the Budget Stability and Fiscal Sustainability Law

Request to the Ministry of Finance to activate the

corrective, preventive and coercive mechanisms

Economic and Financial Plans

Follow-up of the entire budgetary cycle: analysis ex ante included (alert/preventivetask)

Long-term sustainability analysis

Mandate: to guarantee effective compliance with the principle of budgetary stability

enshrined in Article 135 of the Spanish Constitution, and binding to all the Public

Administrations. This mandate is to be carried out through the constant evaluation of the

budget cycle, the public indebtedness and through the analysis of the economic

projections.

2. Mandate

Non exhaustive mandate: AIReF can issue opinions on its own accord

It comprises every Public Administration

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2. Mandate

In a decentralized system, the implementation of fiscal becomes complex:• Multiple agents• Fiscal responsibility is diluted• Horizontal and vertical asymmetries in the constraints of fiscal policy

IFI’s contributions:• Multiplying effect: its functions and benefits impact every level• Consistent implementation amongst the different levels moral authority• Arbiters of the relationships among the different levels of Government• Provision of elements for positive analysis, which are essential for making

decisions that affect various regions (funding system). Improvement of thecoordination mechanisms

Exportable to countries with strong sub-national spending capacity and regional fiscal tensions

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2. MandateWhich Government responsibilities are transferable to an IFI?

Minimum set of core tasks for positive analysis:

• Analysis/production of economic forecasts (identification of bias)• Follow-up and analysis ex ante and ex post of fiscal targets (and rules, where

applicable). Ex ante, relevant alert.• Long-term analysis of fiscal policy: analyze sustainability, underlying trends

(aging) and identification of fiscal risks

Other related tasks can be undertaken as the institution becomes moreconsolidated, but these require more resources:

• Costing of measures or evaluation of the Government’s estimates• Preparation of the medium-term trend economic and budgetary scenario• Spending reviews: options to reduce spending or efficiency improvements• Opinion on the very design of rules• Assessment of electoral programs

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1. Independence

2. Mandate

3. Functional autonomy

There are three main elements to be highlighted from the already broad international experience

3. Functional autonomy

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The leadership of the IFI must have full management capacity, without any other limits than the ones set forth by legislation, and featuring proper accountability

Funding resources

Dissociated from the Government’s discretional decisions, granting stability over time

Interesting cases:o Portugal: protection

clauses (prevents from cuts)

o Ireland: the Government has limited discretionarypowers over its assignation

o Possibility to have resources of their own: CPB, Portuguese CFP, AIReF

Human resources

Technical competence: civil servants + outside staff

Combination of profiles and nationalities

Selection made by the IFI

Exchanges with IFIs and secondment from other institutions

Access to information

Source of complications, both in legislation and in the practice

Exceptions: long-established IFIs (CPB)

Informal solutions: unstable

Guarantees: legal grounds plus MoUs

It must be an ambitious investment with resources commensurate to the mandate

3. Functional autonomy

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Adequate instruments to fulfill the mandate

Common ground for every IFI

IFIs that perform surveillance of

rules

Broad dissemination of reports and methodology

Allow for the replication of results

Creation of tools for the public

Press conference and briefings

Dynamic website

Basis for a constructive dialogue

Transparent and public dialogue

Communicationand transparency

Comply or explain

Conclusions

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IFIs have been created analogously to Central Banks, to limit the discretionaryscope of Governments. In the specific case of IFIs, to contain the bias towardspublic debt

Unlike monetary policy, democratic legitimacy prevents decisions regarding taxingand spending policies from being delegable to an independent entity whoseleadership has not been democratically elected

What IFIs can do is to contribute with their positive analysis to contain the causes ofthe bias towards deficit (information asymmetry, optimism, short-term approaches,internalization of all the costs…). Thus, the analysis responsibilities can betransferred unto them.

There is a minimum set of tasks that form the core of this positive analysis. As theinstitution consolidates more tasks can be assumed.

Besides, in countries with fiscal rules the IFIs complement them, and limit thepossibility for their discretionary or inconsistent implementation.

Conclusions (2)

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However, for an IFI to be able to fulfill its functions in an effective manner, theinstitution must be independent, with a solid basis and the capacity to bemaintained over time

There is not a single optimal model to guarantee the above conditions, but theResearch Department within Central Banks that resemble longer-established IFIsand proven success (such as the USA CBO and The Netherlands’ CPB) constitute agood reference and model to follow

Both types of institutions share interesting common characteristics:

• The positive analysis of public finances is predominant, and they refrain fromissuing recommendations. They upgrade the quality of public debate and theymake accessible for the general public the implications of fiscal policy and theimportance of fiscal discipline and sustainability

• Decisions are not made by a college but based on the direction of a singleperson instead. The ideal selection system would be a competitive one

• Technical competence, transparency, communication, accountability andexternal controls are the best safeguards for independence and reputation

Conclusions (3)

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In countries with a high level of decentralization, it is convenient that the IFIs’analytical scope goes beyond the federal government level. This is speciallyadvisable when the “no bail-out” clause does not work effectively. In such contexts,the IFI:

• Is a relevant agent that provides objective elements to inform the analysis(about spending necessities or the cost of services) for the latter decisions thataffect various levels of government. The IFI can give a more global view

• Its analysis on the fiscal situation of sub-national governments can beperceived as more neutral (thus, more legitimate)

• On an informal basis, it can help to improve the institutional framework.

Conclusions (4)

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Regarding timing, it only makes sense to establish an IFI when there is a solidintention to back the institution up, featuring a medium-term approach and theproject to make it durable in time. Like in the case of Research Departments inCentral Banks, the institution must have a solid foundation and adequateresources. There must be conviction and commitment: it is better not to create anIFI than to create a superfluous institution.

IFIs are a very good reinforcement to institutional frameworks (like Central Bankswere back in the day) since they provide analysis aimed to guarantee thesustainability of public finances. They contribute to certainty and stability.

With enough commitment, resources and a proper election of the directiveteam, it is not easy but feasible to establish an IFI from scratch. The directiveteam of a newly-created IFI will face important challenges:• Need to gain a good reputation institutional room in a short time• Need to develop analytical capacity and technical competency- gradual development of

models and performance• Initial frictions are ineludible, since the IFI is a new agent amongst many.

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