Fiscal Risk: What is Going on at the Leading Edge, and Where to Next?
Posted by Jason Harris
Fiscal risks are big, bad and occur more frequently than commonly anticipated. FAD hosted a seminar of leading edge countries to identify ways of assessing and managing those risks to reduce their impact on public finances.
The global financial crisis demonstrated just how large, consequential and serious are the fiscal risks that sit outside of the normal budget forecasts. The huge increase in public indebtedness, unprecedented during peacetime, was driven by a combination of the sharp decline in macroeconomic activity, with its consequences for tax and benefits, as well as the realization of fiscal exposures to the banking sector, state-owned enterprises and local governments.
Yet, at the time, few had considered macro shock scenarios anywhere near the magnitude that was experienced, and little was known about the specific risks that rebounded onto the government balance sheets with such unforeseen force.
Since then, considerable work has been done to get a better handle on these fiscal risks. The sophistication and breadth of macro-fiscal analysis has improved considerably. Many countries are now devoting more effort and attention to identifying, quantifying and publishing their specific fiscal risks, such as guarantees and other contingent liabilities. And international agencies are providing more useful and detailed guidance as to how fiscal risks should be assessed, such as in the third pillar of the IMF’s fiscal transparency code and the related evaluations.
Some countries have begun pushing the envelope of fiscal risk analysis and management. This includes looking at the overall balance sheet while setting fiscal policies, extending stochastic macro analysis to encompass contingent liabilities, and undertaking fiscal stress tests to see how the public finances would hold up in the event of another large shock.
Last week in Washington, the IMF brought together some of these leading edge countries for a two day conference, to discuss and compare notes on where best practice on fiscal risk analysis and management is heading.
Key officials from the Australian, New Zealand, UK and US Treasuries, the Dutch Central Bank and the UK National Audit Office joined staff from the IMF’s Fiscal Affairs, Asia Pacific, Monetary and Capital Markets, and Strategy, Policy and Review Departments to run through the latest thinking, and brainstorm some of trickier issues surrounding this work. Some of these issues included:
- How to assess the resilience of public finances to fiscal risk, through new macro-fiscal modelling that integrates probabilities of contingent liability shocks, assessing overall capital at risk, and undertaking fully fledged fiscal stress tests, while bearing in mind the lessons from the crisis, particularly those learned within the financial sector.
- The role of balance sheets, both backward and forward looking, in assessing the solvency of public finances. Particular attention was given to projecting balance sheets forward, integrating long-term fiscal projections into a comprehensive balance sheet and understanding the risk factors behind particular elements of government assets and liabilities.
- Thinking about how to change incentives and behavior to reduce the probability that risks occur, reduce exposure where it is cost effective and create the fiscal space to absorb the remaining risks. This included the thorny problem of coming up with an approach for identifying what a safe level of debt might be for particular countries.
- Figuring out how to best explain this analysis to ministers, and provide useable guidance to policymaking, both from the big picture fiscal policy viewpoint, as well as at the level of individual policies.
The range of approaches being taken by these countries who are involved in pushing out the frontier was encouraging, with a range of complementary but different directions taken. Bringing these different strands together into a practical toolkit for fiscal risk analysis and management, able to be used both by countries at the leading edge and those with less resources and information to draw upon will be a task on which FAD continues to focus.
Watch this space for some new thinking from FAD, with an IMF Policy paper on this topic anticipated in the second half of 2016.
 Senior Economist, PFM Division 1, Fiscal Affairs Department, IMF.
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