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April 18, 2013

Managing Public Finances Is Vital to Economic Prosperity

As posted on IMF Survey Online

Across the world many countries are now grappling with restoring sound and sustainable public finances: the way governments manage their budgets today will have profound economic effects in the years ahead. A new book by the IMF looks at reforms introduced by governments over the past two decades to improve management of public finances. These innovative ideas and reforms are changing the landscape of public finances and eventually aim to fundamentally change the way governments manage the public’s money.

The global financial and economic crisis highlighted the importance of sound public financial management in ensuring that well-designed fiscal policies are implemented effectively. Sound management of public finances means maintaining a sustainable fiscal position, allocating resources efficiently, and delivering public goods and services effectively.

The book looks at how reforms to public financial management make use of new information, processes, and rules to change the behavior of politicians and public servants to counter the ongoing challenges of managing government’s money. As identified in the book, too often the tendency for policy makers is to spend rather than save in good times; to focus on the short term; and to ignore the future costs of new policies, underlying fiscal risk, and the true state of public finances.

“The global crisis has highlighted that reforming governments’ management of public finances is no longer 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 the findings in the book.

Managing the money

Public financial management—the fine art of budgeting, spending, and managing public monies—has undergone something of a “revolution” since the late 1980s. The book poses critical questions about the key innovations which are part of this revolution including among others, new legal frameworks to promote fiscal responsibility, fiscal rules, medium-term budget frameworks, accrual reporting and accounting, performance budgeting, fiscal councils, and new fiscal risk management techniques.

Many governments have set up legal frameworks to promote fiscal responsibility. This means they’ve passed laws intended to improve discipline, transparency, and accountability by committing themselves to clear fiscal policy objectives that can be monitored via strict reporting and publication requirements.

A range of different types of legislation exists, reflecting individual countries’ legal frameworks. In some countries, the legislation requires the government of the day to state its fiscal policy principles and medium-term objectives and to report on whether these objectives are achieved; others support such objectives by imposing long-lasting numerical constraints or fiscal rules, on deficits, debt, expenditure, or revenue. Both approaches can be equally effective to help manage public finances and their underlying policies in a sustainable manner over time. Reliable, timely, and comprehensive information—still a challenge in many countries—is needed to ensure success. Fiscal rules can also sometimes leave little room for governments to make crucial adjustments to fiscal policy when needed to adapt to changes in economic circumstances, so properly designed rules are essential.

The use of medium-term budget frameworks has fostered a more disciplined approach to budgeting and forced governments to look beyond the traditional one year budget horizon and plan for future costs of new policies. Besides ensuring compatibility with other key macroeconomic indicators and objectives such as growth, inflation, and exchange rates, medium-term budget frameworks provide predictability to agencies directly involved with the delivery of public goods and services.

Innovations in accounting and reporting are increasingly being developed and adopted by a growing number of governments. Without good information, governments can’t make good decisions about public finances. And, unless information is published, they are unlikely to be held accountable for those decisions. Reporting before the 2008 global financial and economic crisis gave few warnings of the looming problems. This is why, the book argues, more needs to be done to improve fiscal reporting.

Another change in the fiscal landscape over the past two decades saw a strengthening of public sector performance. During this time, governments sought to improve public sector performance by introducing a number of reforms, including better and more comprehensive ways to measure performance.

Yet, as noted in the IMF research, the assumption that more and better information would provide the right incentives to change behavior has not proved true in all cases. And many governments are doing more to monitor and improve performance, as their citizens have come to expect a higher level of service delivery from the public sector.

Equally important is that information undergoes independent review and validation. In recent years, this gave rise to the proliferation of independent fiscal councils, with a mandate to assess and monitor assumptions underlying budget formulation, and the implementation and the impact of fiscal policy vis-à-vis stated objectives. Where fiscal rules are in place, such councils can help enforce compliance with these rules.

Changing fiscal environment

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

Fiscal risk 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 in identifying, disclosing, and managing fiscal risks, and the IMF book identifies international initiatives from the past two decades that improved information on fiscal risks and the effectiveness of fiscal risk management.

Lessons drawn in the book will help guide policy makers in the next generation of reforms, the authors say.

The crisis highlighted the limitations of some countries’ public financial management frameworks and the weak implementation of certain reforms. Some reforms were introduced in isolation without taking into account the other components needed to support them—for example, new risk management techniques without the necessary fiscal reporting to generate needed information, or fiscal rules without supporting budgetary frameworks.

The components of a modern framework are intrinsically linked and understanding the interdependency can help decision makers design effective reforms. With no “magic bullet” solution available to accomplish reform, policy makers are turning to the ever-evolving work on public financial management and learning reform is continuous and needs to constantly adapt to changing circumstances and to individual country contexts.

Public Financial Management Fast Facts

  • The number of countries with fiscal rules rose from 5 in 1990 to 76 in 2012.
  • The number of countries with medium-term budget frameworks increased from under 20 in 1990 to more than 130 in 2008.
  • The number of countries with fiscal councils grew from about 6 in 1990 to about 25 in 2013. (ten or more councils created since 2008).
  • With the emergence of new fiscal reporting standards, the number of countries reporting at least a financial balance sheet to the IMF increased from 21 in 2004 to 41 in 2011.
  • By 2007, 80 percent of Organization for Economic Co-operation and Development countries produced performance information, and in 2011 nearly 70 percent had a standard performance budgeting framework.
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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