International Regulatory Framework
Independent Fiscal Institutions: Context
In the fiscal policy area, excessive deficits leading to rising debt-to-GDP ratios, and a tendency to spend temporary revenue windfalls (procyclicality in good times) are two widespread and well-documented biases. They often reflect failures to coordinate competing claims from various constituencies on the revenue pool (the so-called common pool problem), politicians’ re-election concerns (leading to myopia when re-election is fundamentally uncertain, or opportunistic pre-election spending), or an imperfect understanding of the government’s budget constraint in the population at large (“fiscal illusion”). The latter problem is particularly relevant in resource-rich countries, where the complexities of assessing commodity cycles and large short-term spending pressures may lead to insufficient savings. As policy biases are invariably rooted in inadequate policymakers’ incentives, the prospective solutions have in common an attempt to get these incentives right.
Ways to correct policy biases generally rely on one or a combination of the following approaches:
- · Rules. Rules seek to impose a direct and durable constraint on policy choices, imposing limits on variables that are generally close to policy instruments (i.e. under good control of policymakers). Prominent examples include limits on the growth of monetary aggregates in the late 1970s and 1980s, and ceilings on government deficit and debts laid out in EU law, or balanced budget rules in most US states.
- · Independent authorities. The delegation of policy instruments to independent agencies is another way to get incentives right. The main characteristics of these arrangements are strict guarantees of independence for the agency, a well-defined mandate against which the agency can be held accountable and complete discretion for the agency in setting the delegated policy instruments to achieve its goals. Perhaps the best illustration of the delegation approach is the exercise of monetary policy by independent central banks.
- · Influence and persuasion. Softer institutional arrangements exist for policies that (i) are not amenable to rules (mainly because they are inherently complex and not easily measurable, such as structural policies), and/or (ii) cannot be delegated outside the political sphere for clear normative reasons (mainly because they are distributive in nature, such as tax and transfer policies). These soft arrangements include the routine surveillance activities of international or supranational institutions as well as the work of watchdog bodies, whose role is to enrich the public policy debate through analysis, information, and advice.
Independent Fiscal Institutions: Role and Institutional Arrangements
A fiscal council is a permanent agency with a statutory or executive mandate to assess publicly and independently from partisan influence government’s fiscal policies, plans and performance against macroeconomic objectives related to the long-term sustainability of public finances, short-medium term macroeconomic stability, and other official objectives. In addition, a fiscal council can perform one or several of the following functions: (i) contribute to the use of unbiased macroeconomic and budgetary forecasts in budget preparation (through preparing forecasts, or proposing prudent levels for key parameters), (ii) identify sensible fiscal policy options, and possibly, formulate recommendations, (iii) facilitate the implementation of fiscal policy rules, and (iv) cost new policy initiatives.
The definition accommodates a great variety of institutional arrangements, while highlighting some of the key functions a fiscal council would be expected to perform.
A fiscal council does not need to be a stand-alone institution akin to a central bank. The notion of “independence” primarily refers to guarantees of non-partisanship in performing its tasks—or operational independence—rather than the strict legal separation that the delegation of policy prerogatives requires. This explains why fiscal councils with an executive mandate can qualify as “independent” institutions under the definition. In general, and without prejudice of its overarching objective to promote fiscal sustainability, the council would be expected to benchmark its assessments against official policy objectives,7 as using its own benchmarks could place it in the partisan fray and undermine its legitimacy. The definition thus accommodates fiscal councils embedded in—and therefore directly accountable to—ministries or parliaments, as well as the possibility for existing institutions, such as audit offices or central banks, to have a “fiscal council” leg.
The work of the council is distinct from audit. First, the work of a fiscal council is macroeconomic in nature, as opposed to the mainly legal and more micro-economic approach underlying audit. Second, the fiscal council’s work is also expected to play a key role at the planning and policy-formulation stage, while audit focuses strictly on ex-post evaluations.
Overall, the paper’s definition is consistent with three broad institutional models of fiscal councils:
a. Stand-alone institutions are the closest to the model suggested in the academic literature. They have no organic link with policymakers beyond appointment procedures and accountability mechanisms, and often emanate from comprehensive Fiscal Responsibility Laws that include explicit guarantees on their independence.
b. Fiscal councils formally under the executive or legislative branch of the political system range from legally separate entities with a well-defined mandate and strict guarantees of independence to bodies that are integral part of parliament (often known as a parliamentary budget office) or a ministry. The latter tend to extract their operational independence from the reputational benefits associated with their non-partisan role in the budget process and the public debate.
c. Fiscal councils associated with other independent institutions can be found in central banks, audit institutions, and independent statistical agencies. That approach allows the council to immediately benefit from the independence of its host and from economies of scale, but requires clear procedures to avoid confusions regarding the respective mandates and functions of the host and the guest.
Independent Fiscal Institutions: Functions
In line with the definition proposed above, the functions of fiscal councils generally belong to one of the following broad categories:
- Independent analysis, review, and monitoring of government’s fiscal policies, plans, and performance. This includes reviews of governments’ annual or medium term budget proposals generally with respect to compliance with official objectives—such as those enshrined in fiscal policy rules—and/or the long-term sustainability of public finances and the related risks. Typically, fiscal councils focus on a macroeconomic analysis anchored in their ultimate objective to promote sound fiscal policies by informing the public debate. Fiscal councils also provide ex-post assessments of macroeconomic and fiscal performance against official aggregate objectives and targets. More broadly, councils also carry out research with clear relevance for the health of public finances and the conduct of fiscal policy, such as labor market performance, the impact of aging population, or the extent of tax expenditures.
- Developing or reviewing macroeconomic and/or budgetary projections. Assessments of macroeconomic and/or budgetary forecasts can be associated with a right to publicly denounce eventual biases or an obligation—de jure or de facto—from the government to “comply or explain” in case of significant differences between the forecasts underlying budget plans and those of the council. The council could also be mandated to prepare the macroeconomic forecasts used for budget preparation or to set key assumptions and parameters, such as a prudent price level for certain commodities with a large budgetary impact (either because the country is a large commodity producer or because of extensive subsidy schemes).
- Costing of budget and policy proposals, including possibly, election platforms. Beyond macroeconomic and revenue forecasts, a fiscal council could also be tasked to produce unbiased estimates related to specific spending programs or policy measures.
- Advising policymakers on policy options. This function can be general—a right to comment and issue recommendations on any policy issue of its choosing—or specific— limited to a particularly contentious issue that must be solved by consensus. A general function is better suited to countries with an already rich public debate and a relatively consensual approach to policy-making. A specific function can be useful in issues such as the sharing of certain revenues across unequal regions, where a consensus must be found but interests among decision makers diverge strongly. In resource-rich economies, issues related to the regional and intergenerational distribution of revenues from non-renewable commodities is also an area where non-partisan inputs could avoid undesirable biases.
Independent Fiscal Institutions: Prerequisites for Institutional Effectiveness
By contrast, significantly higher primary balances are associated with fiscal councils featuring certain characteristics. Note that because fiscal councils generally combine several of these features, this simple regression analysis does not identify “sufficient conditions” for effectiveness. For instance, the task of monitoring compliance with fiscal rules (point b) is unlikely to be sufficient to impact fiscal performance if it is not paired with strict independence and a presence in the public debate.
- Legal and/or operational independence. This result is particularly strong if one considers countries providing legal guarantees on the independence of their councils, and those allowing for a staff commensurate to the tasks of the council—an important element of operational independence. While it was argued earlier that explicit safeguards on funding were useful to avoid retaliatory cuts, this feature alone does not seem to characterize the most effective councils in the sample.
- Monitoring compliance with fiscal rules. The positive and quantitatively large effect seemingly associated with such fiscal councils is consistent with the likely beneficial combination of the two types of arrangements. That said, the strength of that potential complementarity could not be directly estimated.
- Assessing or producing forecasts. This result is arguably linked to the previous one, as overoptimistic forecasts are often a way for governments to escape to the strictures of numerical fiscal rules (Frankel and Schreger, 2013). Although this only increases ex-ante compliance with the numerical targets, the cost of non-compliance ex-post is generally low given the weak enforcement mechanism characterizing many fiscal rules.
- Strong media presence. This result is consistent with the fact that the effectiveness of a fiscal council hinges importantly on the reputational and electoral impact of its analysis for policymakers.
X. Debrun, T. Kinda, T. Curristine, L. Eyraud, J. Harris, J. Seiwald, 2013, "The Functions and Impact of Fiscal Councils," IMF Policy Paper; July 16, 2013, International Monetary Fund, Washington, DC.
X. Debrun, V. Lledó, X. Zhang, R. Beetsma, X. Fang, Y. Kim, S. Mbaye, and S. Yoon, "The Rise of Independent Fiscal Institutions: Recent Trends and Perspectives", IMF Working Paper forthcoming, International Monetary Fund, Washington, DC.
Fore more details, please see Fiscal Council Dataset available on the official web-page of the International Monetary Fund.
International Standards/Principles for IFIs