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«Public Debts: Nuts, Bolts and Worries Barry Eichengreen, Robert Feldman, Jeffrey Liebman, Jürgen von Hagen and Charles Wyplosz  ICMB INTERNATIONAL ...»

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The new institution again matches the delegation nature of the British political system. Indeed, like the Dutch CPB, the OBR is embedded into the UK Treasury, so that its role is to reinforce the credibility of the work that is conducted there. Still, it has weaknesses. It depends entirely on the Treasury for data and for much of its analytical work. While its Board includes individuals with impeccable credentials, it lacks the independent staff and resources that provide true independence. In addition, there still is no formal numerical rule. While the government now has to state publicly and formally its medium targets, the targets can be changed or ‘adjusted’ when circumstances change. Both shortcomings could be alleviated by a practice seen as truly independent in the OBR’s early years, following classic British-style common law tradition, but this remains to be seen. Surely, more independence and formal rules could be added.

France The last year when the French budget was balanced was 1974. The public debt has been increasing relative to GDP ever since. Public opinion has never attached great attention to the lack of discipline of its various governments, focusing instead on the classic common pool practice of requesting more public spending Recommendations 115 and more transfers while disapproving of tax increases. ‘Austerity’ is a word that guarantees electoral loss.

Policymakers have long been aware that the public debt has not been stabilised.

Numerous commissions have been appointed and each has produced reports confirming the lack of discipline and making proposals for reform. As a result, a number of steps have been taken to constrain the budget preparation process. But these steps have not gone as far as establishing a rule or an independent watchdog.

France has a mixed presidential-parliamentarian regime: it is presidential when the presidency and the Assembly (the lower chamber) are controlled by the same party, it is parliamentarian in the opposite case. The majority is always dominated by a single party, which suggests that France is a delegation country. Indeed, the finance minister has large agenda-setting power, but this power is shared with the president or parliament according to the prevailing regime.

Two arrangements, the LOLF (Loi Organique des Lois de Finance) and the RGPP (Revision Générale des Politiques Publiques), entered into force in 2006 and 2007, respectively. Their objective, however, is less fiscal discipline than effectiveness of public spending. Importantly, the LOLF brings together a series of disparate budgets – mainly state and welfare – that used to be treated separately. Indeed, until then, these budgets were treated completely separately, with the result that deficits were cumulated without policymakers being forced to take a view of the aggregate public deficits. It still is the case that the Parliament votes on two legally distinct budgets (central government and welfare) but the LOLF requires that the overall budget be explicitly acknowledged.

In 2008, a constitutional amendment established the requirement that the overall budget be brought to balance. This has led to three-year budget programmes (Loi de Programmation des Finances Publiques, LPFP), which are required to display a path toward balance. The procedure also requires the finance minister to set ceilings for annual spending and floors for planned annual tax revenues, and the Parliament cannot override the government.

In practice, however, the government can appeal informally to special circumstances and deviate from the pre-specified path. In addition, numerous loopholes exist and they are being actively exploited.81 The first implementation of the LPFP is a case in point. Figure 6.4 shows the evolution of the debt as specified by the law adopted in 2008 for the three-year period 2009–11. Noting the high level of uncertainty created by the crisis, the government remained very cautious and merely aimed at stabilising the debt to GDP ratio. Even so, the actual implementation led to a17 percentage point increase in the ratio.

In practice, the LPFP failed to affect even the public debate, which merely payed lip service to the constitutional request. There are good reasons for that.

First, the law requires a three-year path toward equilibrium but sets no horizon for achieving it. Second, the Higher Court (Cours Constitutionnelle), which theoretically could censure the government, has a history of considering the budget as an instrument rather than the object of any legal commitment. Third, while such departures must in principle be corrected ‘over the next few years’, the 81 As in many countries, ‘tax expenditures’ – tax advantages offered to specific interest groups – have increased considerably.

116 Public Debts: Nuts, Bolts and Worries horizon is not specified. Fourth, the LPFP concerns the budget law, not the budget execution. The relevant court (Cours des Comptes) publishes a report several months after the annual budget has been closed, letting all bygones be bygones.

Fifth, various budgetary laws accumulated over the years have created a maze of rules so opaque that only few people – budget policy insiders – understand them.

This strengthens the common pool problem. Finally, the finance minister could use its power to constrain the process but, historically, it has never stood up to the president and to the parliament.

In conclusion, the constitutional budget requirement is a statement of intention with no rule, no binding constraint, and no enforcement mechanism.

The existing watchdogs are courts with limited economic expertise and a long tradition of avoiding any confrontation with the government on macroeconomic matters.

Figure 6.4 Gross public debt in France (% of GDP)

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Presentation of the country chapters Ted Truman, Peterson Institute of International Economics, Washington Ted Truman started by noting the importance of the topic and by stating that he particularly appreciated the Geneva Report’s wealth of information, the combination of a retrospective look into the causes of the current state of the world and the forward-looking projections, the focus on institutions and the associated political economy issues, and the discussion of particularities of each country. He shared the view of the authors that the 90% debt/GDP threshold that is believed to be critical for debt distress is too simplistic and added that the three cases presented face different degrees of urgency. He also referred to a recent IMF study on ageing.

He was not convinced that the common pool hypothesis was at the key explanation of why democracies generate excessive debt levels. The common pool hypothesis can explain decisions made at the margin, while most of the tax and expenditure decisions are intra-marginal. Also, the common-pool framework leaves out the role of fiscal policy in macroeconomic stabilisation and the associated decision-making process. Observing that economists’ opinions on the issue remain divided, he wondered how this framework performs historically.

On the issue of urgency, he argued that one should not focus solely on the demographic time bombs, but also on policies, in particular monetary, regulatory and structural policies. He observed that international interactions matter, in particular the potential advantages or disadvantages of moving first or last. Also, he stressed the potential relevance of countries outside the G3 for the analysis, for example their investment and savings rates.

Commenting on the US case, he appreciated the historical dimension and agreed with the basic message that a solution will be eventually found but that there is considerable uncertainty about the choice of policy instruments and about timing. Yet, there is a scope for a balanced approach that would target both revenues and expenditures. He also believed that some institutional innovations are needed but thought that markets are not fooled by the current weaknesses such as the temporary programmes. Regarding timing, he reminded the audience that the last fiscal consolidation in the US took a decade to accomplish. This suggests that it makes sense to wait until after the 2012 presidential election so that it can be fought over fiscal issues.

118 Public Debts: Nuts, Bolts and Worries On the other cases, Ted Truman expressed doubts about fiscal dominance in Europe. He next wondered whether Japan is more or less exposed to a debt crisis than other countries. The conventional argument is that the Japanese are less exposed because they owe their debt to themselves. However, he saw a tension there between people who repay the debt and those that are on the receiving end. Similarly, he was not convinced of disproportional benefits for seniors. In his view, the payments to seniors are a part of a social contract and the seniors think that they paid for their benefits in advance. In that respect, it would be useful to know exactly how much they contributed to the system and how it compares to the promised benefits.

Benoit Coeuré, Ministère de l’Economie et des Finances, Paris Focused on the EU, Benoit Coeuré praised the framework adopted by the Geneva Report and acknowledged the importance of focusing on institutions and implementation. He distinguished two types of issues: How did we get into the present situation and the associated threats? And how do we move back to a sustainable path, and what is needed to succeed in that effort?

Agreeing that public finances in the Eurozone are in an unpleasant situation, he observed that the latest data reveals that the deficits in many countries decreased much more quickly than had been expected. Concerning the ‘business-as-usual’ scenarios presented in the report, he thought that the exercise was a little bit too forward-looking. More effort must be devoted to detect persistence in fiscal patterns because it is difficult to change the way governments are working, especially in large countries. Resistance to change comes from entrenched social preferences, bureaucratic habits, rent-seeking etc. For example, in France the high level of debt before the crisis was not caused by ageing but by increases in social transfers. As a result, if one wants to foresee how current trends can be reversed in the future, it is important to understand why high growth of social spending has been supported in the past. There are various potential explanations: the need to compensate the losers from globalisation, a call for more redistribution as a reaction to rising inequalities, or an increasingly fragmented society laying the ground for attrition wars and delayed fiscal adjustment.

More attention should also be paid to short-term developments beyond longterm trends such as ageing, he said, because the initial position is important, in particular the discrepancy between the cyclically adjusted and the debt-stabilising deficit. The most crucial task is to map the initial dynamics. To illustrate how this should be done, he referred the audience to the European Commission’s S2 indicator (sustainability gap) that is composed of two parts: the initial dynamics and the long-term trends.

Benoit Coeuré next commented on institutions. He felt that the authors of the report underestimate the reforms of the European governance currently under way. He disagreed in particular on the presumed inefficiency of reforms of the Stability and Growth Pact (SGP) in strengthening enforcement at the national level. The package currently under discussion by the European Parliament contains a directive on minimal requirements on national fiscal frameworks.

The package sets a common framework for fiscal policies in the Eurozone Discussion 119 countries with a path for debt-reduction, budget balance targets, and multiyear numerical rules for spending and tax levels. In addition to annual budgets that will be discussed by the national parliaments, a stability programme will be discussed at the European level. This framework is already implemented or under implementation in some countries. In his view, this new system is an important step as it brings more complementarities between national and EU rules, and it assures time-consistency by the introduction of compulsory multiyear planning.

He disagreed with the authors on the notion that growth will not solve the debt problem. He was sympathetic to the idea that growth should not be an excuse for a lack of fiscal efforts, but without raising the level of potential growth Europe cannot get on a sustainable path, no matter what type of fiscal rules will be implemented. So, according to Benoit Coeuré, there is also a need for progrowth institutions, which is discussed neither in the report nor at the European level.

He felt that the issues of monetary policy dominance should be discussed more in the case of the USA than in the case of the Eurozone. First, the Eurozone is the only region where monetary dominance is established in the Constitution.

Second, the security purchase programme implemented by the ECB is too limited to create a significant risk of inflation. Still, even though there is no risk to monetary dominance at the moment, he warned that fiscal dominance might creep in through the mandate given to the central bank on financial stability.

Benoit Coeuré concluded that there was a need to develop more further the consequences of a fiscal crisis to be able to better imagine what would happen if we do not do anything. He felt it was important to explain how disruptive sovereign defaults are, to warn against the risk of monetisation, and to highlight the threat of disappearance of safe financial assets. Fifteen years ago, people discussed what would happen if there was no public debt and the financial markets would have to live without safe assets. Now that there is too much public debt, we face uncertainty regarding the safety of some of these debts.

Kazumasa Iwata, Institute of Economic and Social Research, Tokyo Kazumasa Iwata focused on the case of Japan. He highlighted intergenerational inequality in the social security system, which is unusually large given the otherwise relative small scale of government in Japan. Focusing on the proposed solution, he first dealt with the issue of productivity. The Japanese government produces two versions of medium-term fiscal projections, which differ by the assumptions they make regarding productivity growth. Even under the more optimistic assumptions, the primary budget is projected to be in deficit but the outcome is very sensitive to assumptions. A 1% difference in forecasted productivity growth over the next 10 years produces a 30% difference in the debt-to-GDP ratio. This means that if Japan succeeds in raising productivity growth by 1%, the fiscal benefits will be significant.

Turning to the Geneva Report’s proposal to raise the consumption tax, Kazumasare Iwata presented projections by the Institute of Economic and Social Research. Assuming a 5% increase in consumption tax and 0.9% productivity growth (compared to the 1.9% optimistic scenario of the government), the primary budget still remains in deficit, mainly due to the negative impact of 120 Public Debts: Nuts, Bolts and Worries the consumption tax on output. He also noted that the consumption tax would generate only a one-time increase in consumer prices; therefore it would not help with ending deflation. He suggested a different way to both end deflation and decrease the intergenerational inequality: introduce a tax-financed basic public pension system along with a funded scheme as a second pillar.

He added that in theory, fiscal policy can substitute for monetary policy, for example by enacting an interest rate tax credit, which is equivalent to decreasing the interest rate. In order to shift the tax burden away from labour and toward consumption, one can combine consumption tax increases together with wage tax reductions.

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