Fiscal adjustment in EU countries:Fiscal adjustment in EU countries:A Balance Sheet ApproachA Balance Sheet Approach

Gian Maria Milesi-FerrettiGian Maria Milesi-FerrettiKenji MoriyamaKenji Moriyama

International Monetary FundInternational Monetary Fund

MotivationMotivation

Debate on the design of fiscal rules and Debate on the design of fiscal rules and reforms of the SGPreforms of the SGP

Frequent adoption of ‘creative accounting’ Frequent adoption of ‘creative accounting’ measuresmeasures

Proposals to move fiscal accounting Proposals to move fiscal accounting towards a ‘balance sheet approach’towards a ‘balance sheet approach’

(e.g., new GFS manual) or to exclude (e.g., new GFS manual) or to exclude investment from deficit calculationsinvestment from deficit calculations

What the paper doesWhat the paper does

Sketches government balance sheetSketches government balance sheet

Defines “cosmetic” (nonstructural) fiscal Defines “cosmetic” (nonstructural) fiscal measuresmeasures

Provides examplesProvides examples

Presents empirical evidence on the Presents empirical evidence on the evolution of net worth in EU countries up evolution of net worth in EU countries up to 1997 and thereafterto 1997 and thereafter

A balance sheet approachA balance sheet approach

Stocks:Stocks: Assets Liabilities

Public capital Gross financial liabilities• Gross government debt• Debt held by publ. inst.• Other

Gross Financial assets

A balance sheet approach (contd)A balance sheet approach (contd)

Flows:Flows:

Change in net worth=Change in net worth=

Flow change in financial assetsFlow change in financial assets- Flow change in financial liabilitiesFlow change in financial liabilities

+ Net public investment+ Net public investment

+ valuation effects+ valuation effects

Key issueKey issue

Valuation of public capitalValuation of public capital– Market value (desirable)Market value (desirable)– Book value (feasible)Book value (feasible)

Financial returns on public capital lower Financial returns on public capital lower than on public debtthan on public debt

Intertemporal budget constraintIntertemporal budget constraint

W(t)=net worthW(t)=net worth

G(t)=government spendingG(t)=government spending

T(t)=government revenuesT(t)=government revenues

1 1(1 ) (1 )t i t ii i tt tT r G r W

1 1(1 ) (1 )t i t ii i tt tT r G r W

‘‘Cosmetic’ measuresCosmetic’ measures

Measures that improve the fiscal balance Measures that improve the fiscal balance and/or reduce gross government debt....and/or reduce gross government debt....

But do NOT reduce the present value of But do NOT reduce the present value of future taxes needed to finance future future taxes needed to finance future spending and repay existing debtspending and repay existing debt

Examples of ‘cosmetic’ measuresExamples of ‘cosmetic’ measures

Sale of public assetsSale of public assets

Securitization operationsSecuritization operations

Capital injections and recapitalizationCapital injections and recapitalization

Off-budget itemsOff-budget items

Quasi-fiscal activitiesQuasi-fiscal activities

Change in government balance sheets:Change in government balance sheets:key questionskey questions

Did fiscal rules lead to “fiscal adjustment”? Did fiscal rules lead to “fiscal adjustment”?

Are changes in government debt Are changes in government debt improving net worth? improving net worth?

Which countries have relied more heavily on Which countries have relied more heavily on sales of public assets?sales of public assets?

Empirical approachEmpirical approach

Collection of data on ‘cosmetic’ measures Collection of data on ‘cosmetic’ measures difficult to undertakedifficult to undertake

Hence indirect approach: compare Hence indirect approach: compare “Maastricht variables” with dynamics of net “Maastricht variables” with dynamics of net worthworth

Limitations of approachLimitations of approach

Misses reforms that alter future taxes and Misses reforms that alter future taxes and spending (e.g.: pension reforms)spending (e.g.: pension reforms)

Large measurement problemsLarge measurement problems

Symmetric reductions of public assets and Symmetric reductions of public assets and liabilities may be desirable (e.g.: liabilities may be desirable (e.g.: privatization)privatization)

Political economy insightsPolitical economy insights

““creative accounting” measures more creative accounting” measures more likely when rules are more stringentlikely when rules are more stringent

Optimistic forecasts more likely when Optimistic forecasts more likely when governments discount the future more governments discount the future more heavilyheavily

Change in public assets and initial debt, 1992-97Change in public assets and initial debt, 1992-97

Austria

Belgium

Denmark

Finland

FranceGermany Greece

Ireland

ItalyLuxembourg

Netherlands

Portugal

Spain

Sweden

United Kingdom

y = -0.17x + 10.9

R2 = 0.23

-30

-20

-10

0

10

20

30

40

0 30 60 90 120 150

Government debt in percent of GDP (avg 1990-92)

Cha

nge

in a

sset

s, 1

992-

97 (p

erc.

of G

DP)

Change in public assets and liabilities, 1992-97Change in public assets and liabilities, 1992-97

Austria

Belgium

Finland

France

Germany

Italy

Netherlands

Spain

Denmark Sweden

United Kingdom

y = 0.73x - 11.8

R2 = 0.73

-30

-25

-20

-15

-10

-5

0

5

10

15

20

-10 -5 0 5 10 15 20 25 30 35

Change in liabilities

Cha

nge

in a

sset

s

Changes in net worth and changes in liabilities, 1992-97Changes in net worth and changes in liabilities, 1992-97

0

10

20

30

40

50

60

70

80

90

1st Qtr 2nd Qtr 3rd Qtr 4th Qtr

East

West

North

Austria

Belgium

Finland

France

Germany

Italy

Netherlands

Spain

Denmark

Sweden

United Kingdom

y = -0.27x - 11.8

R2 = 0.28

-25

-20

-15

-10

-5

0

-10 -5 0 5 10 15 20 25 30 35

Change in liabilities

Cha

nge

in n

et w

orth

Figure 2. Changes in government liabilities and in net worth: 1992-1997

Change in public assets and liabilities, 1997-2002Change in public assets and liabilities, 1997-2002

Portugal*

United KingdomSweden

Denmark

SpainNetherlands

Italy Germany

France

Finland

Belgium

Austria

y = -0.09x - 2.7

R2 = 0.01

-15

-10

-5

0

5

10

15

20

-25 -20 -15 -10 -5 0 5

Change in liabilities

Cha

nge

in a

sset

s

Changes in govt liabilities and net worth, 1997-2002Changes in govt liabilities and net worth, 1997-2002

Portugal*

United Kingdom

Sweden

Denmark

SpainNetherlands

Italy

Germany

France

Finland

Belgium

Austria

y = -1.06x - 2.3

R2 = 0.66

-15

-10

-5

0

5

10

15

20

25

30

35

-25 -20 -15 -10 -5 0 5

Change in liabilities (percent of GDP)

Cha

nge

in n

et w

orth

(per

cent

of G

DP)

Growth forecast and budget balanceGrowth forecast and budget balance

Austria

BelgiumFinland

France

GermanyIreland

Italy

Netherlands

Portugal

Spain

Greece

y = -0.26x - 0.58

R2 = 0.59

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

-8 -7 -6 -5 -4 -3 -2 -1 0

Average budget deficit, 1995-1997 (percent of GDP)

Gro

wth

fore

cast

(dev

iati

on fr

om C

onse

nsus

)

Summary of findingsSummary of findings

1992-1997 Changes in financial liabilities 1992-1997 Changes in financial liabilities reflect primarily changes in public assets;reflect primarily changes in public assets;

1998-2002 Change in financial liabilities 1998-2002 Change in financial liabilities reflect primarily changes in net worthreflect primarily changes in net worth

Governments with more serious fiscal Governments with more serious fiscal problems tend to be more optimistic than problems tend to be more optimistic than markets about growth prospectsmarkets about growth prospects

ConclusionsConclusions

Fiscal rules can be helpful...Fiscal rules can be helpful...

But it is important to understand the But it is important to understand the incentives they set in place....incentives they set in place....

...and monitor fiscal developments more ...and monitor fiscal developments more broadlybroadly