Fiscal Rules

Eldad Shidlovsky ,Head of Economics and Research Department. Ministry of Finance

May 2009

Ministry of Finance

2

Fiscal Rules - Historical Perspective

The “Deficit Reduction Law” was enacted in 1992.

In the first few years, it addressed only the level of the deficit.

In 2005 an expenditure limit was added.

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Fiscal Rules - Historical Perspective

4.2% 4.0%

3.2% 3.1% 3.1%

0.6%

4.1%

3.5%

5.3%

3.6%

1.8%

1.0%

0.0%

2.1%

0%

1%

2%

3%

4%

5%

6%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Central Government's Budget Deficit)As Percent of GDP(

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The Use of Fiscal Rules in other Countries

The rules vary among countries: The rules refer to the public sector as a whole or

to the central government budget. The rules focus on the size of the deficit, on

public debt, size of public expenditure etc. Some countries set rules for one year, some use

multi-year rules, and some apply rules over the course of the business cycle.

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Why are Fiscal Rules Necessary?

Creation of budgetary anchors that prevent sliding into a loss of fiscal control.

Increased stability and credibility of economic policy in the eyes of the public.

Increased budgetary transparency. Support for improved efficiency of the

public sector.

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Difficulties in Applying Fiscal Rules

Difficulty in applying anti-cyclical policy.

Postponement of expenditures. The need to abstain from solutions

that bypass the budget.

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Guidelines for the Proposed Fiscal Rule

Avoiding as much as possible the use of economic forecasts.

The rule should be as simple and transparent as possible.

The rule should maintain the credibility of budgetary policy.

The rule should prevent the need for frequent changes, exceptions (such as the "boxes"), and solutions that bypass the budget.

The rule should not create a pro-cyclical policy.

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Key Objectives in Establishing the Fiscal Rule

The key objective in the short term is a return to fiscal stability by committing to a downward deficit trend.

The key objective in the medium and long term is to achieve a decrease of the debt-to-GDP ratio to around 60 percent by the end of the next decade.

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Reasons for Reduction of the Debt-to-GDP Ratio

173

113101

9278 73 73 72 71

65 63 63 59 57 55 53 48 45 45 44 40 38 36 33 33 28 25 2518 14

0

20

40

60

80

100

120

140

160

180

200 Gross Public Debtpercent of GDP, estimates 2008*

*Source: OECD, November 2008, Israel: MoF

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Reasons for Reduction of the Debt-to-GDP Ratio

Increases the economy's resilience to external shocks.

The burden of defense spending. Population aging. Debt reduction decreases interest

expenses and financing costs.

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The Proposed Rule

The fiscal rule will be based on two components:

A restriction of real expenditure growth. Future increase in expenses will be a

function of the debt-to-GDP ratio. A budget deficit ceiling – the budget deficit

ceiling will decrease gradually.

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The Proposed Rule

64.5%

40%

50%

60%

70%

80%

90%

100%

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Development of the debt-GDP ratio simulation, 2007-2020

Growth assumptions: GDP growth will be -1% in 2009, 1.5% in 2010 and

3.5% thereafter