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June 23, 2010

The Role of Independent Fiscal Institutions in Fiscal Management: The Perspective from an International Conference in Hungary

Posted by Dávid Mihályi[1] 

On March 18-19, 2010, the Fiscal Council of the Republic of Hungary hosted a conference on independent fiscal institutions at the Hungarian Academy of Sciences, in Budapest. Speakers included heads of sister institutions, senior government officials, and academics from more than 20 countries. The principal objective of the conference was to examine the experience of independent fiscal institutions in promoting the transparency and sustainability in public finances.

In the wake of the global financial crisis, with public debt reaching historical heights, policymakers are exploring solutions to unprecedented problems with sovereign debt sustainability. As minor adjustments appear insufficient to ensure medium-term consolidation, many advanced and emerging-market economies have introduced, or are about to introduce, a comprehensive fiscal policy framework to strengthen their commitment to fiscal responsibility. This often includes setting permanent fiscal policy and procedural rules. In addition, as part of the framework, an increasing number of governments have established independent fiscal institutions to ensure the reliability of government accounts and projections, and to monitor compliance with fiscal rules. The conference provided a forum for discussing accumulated experience and emerging best practices in this area.

The conference began with an introductory session, including keynote speeches, followed by two sessions devoted to the experience of independent fiscal institutions in the Americas and Europe. A subsequent session addressed selected analytical and institutional issues. The conference concluded with a panel discussion on future prospects.[2]

In his opening remarks, László Sólyom, President of the Republic of Hungary, emphasized the importance of maintaining credibility and transparency in the budget process. He explained that his support for creating the Fiscal Council of Hungary was prompted by concerns regarding the rapid buildup of public debt in recent years and the ensuing burden on future generations. The President also shared his insights concerning the political process that led to the creation of the Fiscal Council.

János Kornai sought to distinguish between the areas of involvement for economists: policy analysis and policymaking. In line with this distinction, independent fiscal institutions should be active in the surveillance of budget and tax policy, without getting involved in actual policymaking which should remain in the hands of elected officials. This implies that independent fiscal institutions provide impartial quantitative assessment of the fiscal consequences of policy alternatives in order to assist policymakers arriving at informed decisions and to increase public awareness of fiscal issues.

In her keynote address, Alice M. Rivlin discussed the early history of the U.S. Congressional Budget Office (CBO) and the challenges it faced in its first years of operation. Reflecting on her tenure as the first head of CBO, she reflected on efforts to build a reputation of professional excellence and non-partisanship for the institution, which succeeded only after the first change in government—from a Republican to a Democratic administration. CBO established itself as a “score-keeper” and avoided taking a stand on specific policy measures. By applying principles of transparency and non-partisanship, CBO could help political leaders face difficult policy choices, including in the run-up to presidential and legislative elections. She noted the timeliness of the conference and called for the creation of independent fiscal institutions to meet the challenges faced by many governments around the world.

In the United States, the experience of CBO, spanning over three decades, provides rich insights for similar institutions elsewhere (Eugene Steuerle and Stephanie Rennane). The CBO has succeeded in increasing the transparency of fiscal policy and in reducing bias official expenditure and revenue estimates. However, it has had mixed success in prompting policymakers to address the long-term implications of current policies that threaten future growth and welfare. CBO can be characterized as a quasi-independent institution: whereas its methods and estimates are shielded from political influence, its work program is driven largely by the legislature.

Canada’s Parliamentary Budget Office (PBO) is of more recent vintage than the CBO, and its resources—in both appropriations and staff—are much more modest (Kevin Page). This implies a significant constraint on fulfilling its main function, namely, of preparing detailed cost estimates of budget proposals. Although independent-minded and attached to Parliament, the head of the PBO is appointed, and can be dismissed, by the Prime Minister. Nonetheless, PBO has made major gains toward a more open and informed budgetary process.

Chile differs markedly from most other countries in that it has two independent groups of experts responsible for monitoring observance of a set of fiscal policy rules (Klaus Schmidt-Hebbel). Specifically, they are entrusted with verifying the reliability of structural budget balance estimates and of the mechanics of the copper stabilization fund. Although consistent monitoring of this fiscal framework has helped the accumulation of a significant level of reserves that permitted to offset the negative fallout from the global crisis, Chile has failed to adopt a sufficiently counter-cyclical fiscal stance in recent years. 

As the oldest economic research institution of its kind, the Netherlands’ Central Planning Bureau (CPB) has expanded its mandate to monitor government policy and forecasts (Frits Bos and Coen Teulings). With a rather sizable professional staff, the CPB not only has the capacity to assess the consequences of the government budget, but is also open to evaluating the economic program of each political party prior to elections. The Bureau’s assessment of the sustainability of public finances encompasses the impact of ageing, resource depletion, and financial crises.

In Belgium, the High Council of Finance made a major contribution to fiscal consolidation in the run-up to launching the euro (Luc Coene). The role of the Council in promoting budget discipline and coordination has been particularly critical in the context of Belgium’s complex federal structure. As the influence of the Council has clearly waned following adoption of the euro, there remains scope for strengthening numerical and procedural fiscal rules to enhance the Council’s effectiveness in the difficult consolidation task that lies ahead.

The Swedish Fiscal Policy Council has a broad remit: in addition to monitoring the sustainability of public finances (through application of fiscal rules) and evaluating the adequacy of the fiscal stance from a cyclical perspective, it analyzes developments in long-run employment and growth (Lars Calmfors). The Council’s very limited resources are complemented by an array of pre-existing independent public bodies responsible for preparing detailed budget estimates and macroeconomic forecasts, and by a strong tradition of academic participation in the policy debate.

Hungary’s Fiscal Council, created following almost a decade of fiscal mismanagement, is responsible for supervising compliance with fiscal rules and transparency norms, with a view to restoring public debt sustainability (George Kopits and Balázs Romhányi). To this end, it exercises timely surveillance of the budget bill and prepares baseline macro-fiscal projections. In its first year of operation, the Council was effective in fulfilling this mandate; however, the jury is still out, insofar as policymaking has been constrained under an EU/IMF-supported stabilization program.

The rationale for establishing independent fiscal institutions is rooted in the rise in public indebtedness (Kenneth Rogoff and Julia Bertelsmann). The inherent bias of governments toward accumulating excessive deficits, driven by time inconsistency, seems to be a widespread and recurrent phenomenon. The resulting high public debt burden has immediate costs in terms of depressed growth, high inflation and high interest rates. Independent fiscal institutions can help overcome these problems by improving transparency and raising public awareness, through dissemination of information on actual budgetary costs, effective oversight of public spending and taxation, and efforts at containing further indebtedness.

Independent fiscal institutions should pursue three objectives (Jürgen von Hagen): improving transparency and predictability, overcoming time inconsistency, and solving the common pool problem. Fiscal institutions may be assigned different weights to these aims, depending on local needs. In Greece, for instance, given serious transparency and accountability problems, such an institution would have to ensure the reliability of information on government finances. On the other hand, the experience of Germany has shown that reduction of the federal deficit has only produced larger deficits at the state and local levels; hence, the institution would have to address the common pool problem, in part by setting debt limits and controlling budget policies at the sub-national levels.

Although independent fiscal institutions and central banks are seen as a means to eliminate time inconsistency, this apparent similarity is misleading (Simon Wren-Lewis). Although the logic behind delegation of certain responsibilities and powers to independent institutions may make these two types of institutions look alike, the similarity does not go very far. The lack of a theoretical consensus concerning optimal debt targets – as distinct from inflation targets pursued by central banks – implies that operational objectives, procedures, performance indicators, organizational profiles and institutional governance of these agencies are necessarily different.

The concluding panel discussion addressed the case, and prospects, for independent fiscal institutions in some European countries where the adoption of such institutions is under consideration. At the most advanced stage of preparation, in the United Kingdom, was the Office of Budget Responsibility (Robert Chote). The Office was in fact introduced by new government immediately after the elections, with the objective of promoting transparency in government finances—to be accomplished in part by taking over from the Treasury responsibility for macro-fiscal projections. In France (Jacques Delpla) and Slovakia (Lajos Ódor) such an institution was envisaged mainly to oversee compliance with fiscal rules, still at the design stage. In Greece, an independent parliamentary office would be a useful vehicle to bolster the credibility of the ongoing fiscal consolidation (Vassilis Rapanos).

Conference participants agreed that independent institutions, possibly coupled with fiscal policy rules, can contribute significantly to restoring and maintaining fiscal sustainability. To enhance its effectiveness, an independent fiscal council or budget office needs a minimum degree of support from most political parties especially at the very outset. Also, early on, the fiscal council must assert its independence from government influence and build a high level of technical expertise, so as to gain credibility in the eyes of political leaders, financial markets, and the public at large.

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[1] Dávid Mihályi is a staff of the Fiscal Council of the Republic of Hungary. This article will appear in the September issue of Acta Oeconomica.

[2] See the program.

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.

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Independent fiscal institutions should be active in the surveillance of budget and tax policy.

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