A Balance Sheet Approach to Fiscal Policy

The fiscal balance is improving, but it should be carefully managed over the next two years.

The right balance today requires creating jobs partly through additional fiscal stimulus aimed at productive infrastructure investment.

Sweden and Chile are almost poles apart geographically, but both have used sophisticated fiscal rules successfully. Chile sets a target for its cyclically adjusted fiscal balance that is, the balance that emerges after accounting for the deviations in commodity prices and domestic output from their trends.

Between 2001and 2006, Prime Minister Junichiro Koizumi aggressively tackled Japan s fiscal problems. Koizumi sought smaller government and set clear numerical targets for fiscal consolidation, including a primary budget balance in 10 years.

That is how the turnaround of the economy took place by reducing the fiscal deficit and converting the external balance of payments from deficit to surplus.

The fifth option is to tighten fiscal policy and reduce budget deficits with the aim of lowering the high interest rates that drive the inflows. But sounder fiscal policy might lead to even higher inflows as the country s external balance and sovereign risk outlook improve.

Acknowledging that recent fiscal policies had put the US on an unsustainable trajectory of rising public debt, Obama said that moving towards budget balance was now essential for fiscal stability. So he called for a five year freeze on what the US government calls discretionary civilian spending.

Spending cuts and tax increases that in the long run restore fiscal sanity and balance are good. Having them all hit a weak, still depressed economy simultaneously is not good.

What this line of research explicitly does not tell us is that deleveraging will restore growth by itself. No one believes that fiscal balance is the whole growth model anywhere.

To offset the negative impact of private sector deleveraging on growth, the US government has maintained expansionary fiscal and monetary policies. Now, with household debt sustained on a knife edge after feverish government intervention, the fiscal position has deteriorated dramatically and the current account balance has worsened again.

Granting balance of payments support has important fiscal implications, and it is natural that there should be continuing close oversight by those who ultimately provide the capital the IMF s member states.

Fiscal Challenges and Fiscal Follies

According to financial regulation 4.2 (b), The unencumbered balance of the appropriations at the end of the fiscal period shall be surrendered to the Members at the end of the first calendar year following the fiscal period after deducting therefrom any contributions from Members relating to that fiscal period, which remain unpaid, and shall be credited to the Members in proportion to their assessed contributions.

The structural primary budget balance, the International Monetary Fund s preferred measure of fiscal thrust, tightened by an additional 1 1.5 of GDP each year from 2010 to 2012, after which it remained broadly stable. The subsequent two years of neutral fiscal policy has made a positive difference for economic performance.

Most major countries fiscal deficits nowadays reflect the recent collapse of tax revenues that followed the growth downturn, as well as very costly financial sector bailouts. And yet many policymakers are insisting on immediate action to rectify not only fiscal deficits, but also trade imbalances and banks balance sheet weaknesses.

Not only is QE s ability to jumpstart crisis torn, balance sheet constrained economies limited it also runs the important risk of blurring the distinction between monetary and fiscal policy. Central banks that buy sovereign debt issued by fiscal authorities offset market imposed discipline on borrowing costs, effectively subsidizing public sector profligacy.

America and the world should remember Argentina s privatization of its pension system was at the center of its recent fiscal woes. Had Argentina not privatized, its budget would have been roughly in balance.

Several possibilities not mutually exclusive come to mind. One is that some policymakers think that fiscal balance really is the main pillar in a growth strategy Deleverage quickly and get on with it.

In order to avert a likely depression, governments around the world engaged in fiscal and monetary stimulus in the midst of the global financial crisis. They succeeded in offsetting nasty economic dislocations caused by private sector deleveraging, but at the cost of encumbering their fiscal balances and their central banks balance sheets.

Contrary to the prevailing wisdom nowadays, some degree of Keynesian demand management in the transition to a more sustainable growth pattern is not in conflict with restoring fiscal balance over a sensible time period. On the contrary, applied both individually and together, fiscal stimulus and consolidation are necessary parts of the adjustment process.

A healthy state balance sheet could help, because part of the income flowing to capital would go to the state. But, with the exception of China, fiscal positions around the world are currently weak.

Now facing another 20 billion deficit despite temporary tax hikes and spending cuts, California s fiscal woes foreshadow those of many sub national or, indeed, national governments globally. While all must first deal with the current emergency, sensible local fiscal, tax, and political reforms are vital to restore a balance of centralized and decentralized government.

The implications of this shift may be far reaching. The German model for resolving the debt crisis and returning to internal or external balance relies on fiscal consolidation and structural reforms for the deficit countries.

The two areas on which we concentrated those we thought to be the real malaise that lay at the root of Pakistan's economic malaise were the fiscal deficit area and the external balance of payments deficit.

In striking the right balance between immediate economic stimulus and medium term fiscal sustainability, the most urgent step will be to counter properly the looming fiscal cliff, as temporary tax cuts expire and deep, across the board spending reductions kick in automatically. Failure to do so would significantly increase the risk of an outright American recession.

How quickly fiscal retrenchment should be launched and the right balance between higher taxes and lower spending will vary by country, reflecting factors like the strength of the economic recovery, the market s appetite for debt, and initial spending and revenue ratios. But the common objective for fiscal policy must be to support durable medium term growth and job creation.

There was a balance, a five sided balance.

The most likely explanation for this public investment shortfall is fiscal constraints. And, indeed, debt and unfunded non debt liabilities increasingly weigh down public sector balance sheets and pension funds, eroding the foundations of resilient, sustainable growth.

But fiscal policy can. We have an ample choice of public investments that would yield high returns far higher than the real cost of capital and that would strengthen the balance sheets of the countries undertaking them.

And here was the clincher By committing themselves to fiscal tightening, finance ministers gave themselves scope for some fiscal loosening. Proclaiming fiscal virtue enabled them to practice fiscal vice.

Fiscal Follies

To be sure, there has been some progress in the eurozone periphery in the last few years fiscal deficits have been reduced, and some countries are now running primary budget surpluses (the fiscal balance excluding interest payments). Likewise, competitiveness losses have been partly reversed as wages have lagged productivity growth, thus reducing unit labor costs, and some structural reforms are ongoing.

However, macroeconomic stability needs to be understood in a broad sense, which includes not only price stability and sound fiscal policies, but also smoother business cycles, competitive exchange rates, sound external debt portfolios, and healthy domestic financial systems and private sector balance sheets.19 Those variables are not necessarily highly correlated and, consequently, policymakers need to strike a balance between them.

But, they fear that calling for spending cuts will be unpopular, unlike, they hope, demands to balance the budget. For them, the problem with the fiscal cliff is that it does not cut spending enough and raises taxes too much.

White balance

White Balance

White Balance...

White Balance

Gender balance

Gender balance

Europe s Fiscal Wormhole

America s Fiscal Isolationism

Fiscal Apocalypse Now

Germany s Fiscal Follies