Managing Public Finances Is Vital to Economic Prosperity

Asposted on IMF Survey Online

Across the world many countries are nowgrappling with restoring sound and sustainable public finances: the waygovernments manage their budgets today will have profound economic effects inthe years ahead. Anew book by the IMF looks at reforms introduced by governments over the pasttwo decades to improve management of public finances. These innovative ideasand reforms are changing the landscape of public finances and eventually aim tofundamentally change the way governments manage the public’s money.

Theglobal financial and economic crisis highlighted the importance of sound publicfinancial management in ensuring that well-designed fiscal policies areimplemented effectively. Sound management of public finances means maintaininga sustainable fiscal position, allocating resources efficiently, and deliveringpublic goods and services effectively.

Thebook looks at how reforms to public financial management make use of newinformation, processes, and rules to change the behavior of politicians andpublic servants to counter the ongoing challenges of managing government’smoney. As identified in the book, too often the tendency for policy makers isto spend rather than save in good times; to focus on the short term; and toignore the future costs of new policies, underlying fiscal risk, and the truestate of public finances.

“The global crisis hashighlighted that reforming governments’ management of public finances is nolonger an option but a necessity. There is no ‘one-size-fits-all’solution—reforms need to be tailored to countries’ individual circumstances,”said IMF Deputy Managing Director, Min Zhu, who addressed officials,journalists, and academics gathered at a special seminar to discuss thefindings in the book.

Managingthe money

Publicfinancial management—the fine art of budgeting, spending, and managing publicmonies—has undergone something of a “revolution” since the late 1980s. The bookposes critical questions about the key innovations which are part of thisrevolution including among others, new legal frameworks to promote fiscalresponsibility, fiscal rules, medium-term budget frameworks, accrual reportingand accounting, performance budgeting, fiscal councils, and new fiscal riskmanagement techniques.

Manygovernments have set up legal frameworks to promote fiscal responsibility. Thismeans they’ve passed laws intended to improve discipline, transparency, andaccountability by committing themselves to clear fiscal policy objectives thatcan be monitored via strict reporting and publication requirements.

Arange of different types of legislation exists, reflecting individualcountries’ legal frameworks. In some countries, the legislation requires thegovernment of the day to state its fiscal policy principles and medium-termobjectives and to report on whether these objectives are achieved; otherssupport such objectives by imposing long-lasting numerical constraints orfiscal rules, on deficits, debt, expenditure, or revenue. Both approaches canbe equally effective to help manage public finances and their underlyingpolicies in a sustainable manner over time. Reliable, timely, and comprehensiveinformation—still a challenge in many countries—is needed to ensure success.Fiscal rules can also sometimes leave little room for governments to makecrucial adjustments to fiscal policy when needed to adapt to changes ineconomic circumstances, so properly designed rules are essential.

Theuse of medium-term budget frameworks has fostered a more disciplined approachto budgeting and forced governments to look beyond the traditional one yearbudget horizon and plan for future costs of new policies. Besides ensuringcompatibility with other key macroeconomic indicators and objectives such asgrowth, inflation, and exchange rates, medium-term budget frameworks providepredictability to agencies directly involved with the delivery of public goodsand services.

Innovationsin accounting and reporting are increasingly being developed and adopted by agrowing number of governments. Without good information, governments can’t makegood decisions about public finances. And, unless information is published,they are unlikely to be held accountable for those decisions. Reporting beforethe 2008 global financial and economic crisis gave few warnings of the loomingproblems. This is why, the book argues, more needs to be done to improve fiscalreporting.

Anotherchange in the fiscal landscape over the past two decades saw a strengthening ofpublic sector performance. During this time, governments sought to improvepublic sector performance by introducing a number of reforms, including betterand more comprehensive ways to measure performance.

Yet,as noted in the IMF research, the assumption that more and better informationwould provide the right incentives to change behavior has not proved true inall cases. And many governments are doing more to monitor and improveperformance, as their citizens have come to expect a higher level of servicedelivery from the public sector.

Equallyimportant is that information undergoes independent review and validation. Inrecent years, this gave rise to the proliferation of independent fiscalcouncils, with a mandate to assess and monitor assumptions underlying budgetformulation, and the implementation and the impact of fiscal policy vis-à-visstated objectives. Where fiscal rules are in place, such councils can helpenforce compliance with these rules.

Changing fiscal environment

Withoverall economic uncertainty likely to continue into the foreseeable future,the management of fiscal risk will continue to gain prominence. New sources ofrisk and unexpected shocks to government finances, such as in the 2008-09financial crisis, highlighted the importance of managing fiscal risks.

Fiscalrisk exposes governments to unanticipated movements in levels of revenues,spending, the fiscal balance, and the value of assets and liabilities.Conventional government budgeting and reporting had a number of shortcomings inidentifying, disclosing, and managing fiscal risks, and the IMF book identifiesinternational initiatives from the past two decades that improved informationon fiscal risks and the effectiveness of fiscal risk management.

Lessonsdrawn in the book will help guide policy makers in the next generation ofreforms, the authors say.

Thecrisis highlighted the limitations of some countries’ public financialmanagement frameworks and the weak implementation of certain reforms. Somereforms were introduced in isolation without taking into account the othercomponents needed to support them—for example, new risk management techniqueswithout the necessary fiscal reporting to generate needed information, orfiscal rules without supporting budgetary frameworks.

The components of amodern framework are intrinsically linked and understanding the interdependencycan help decision makers design effective reforms. With no “magic bullet”solution available to accomplish reform, policy makers are turning to theever-evolving work on public financial management and learning reform iscontinuous and needs to constantly adapt to changing circumstances and toindividual country contexts.

Public Financial Management Fast Facts

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