McDermott and Wescott examine three definitions of successful fiscal consolidation: 1 a reduction of at least 3 percentage points in the ratioof gross public debt to GDP by the second year after the end of the two-year fiscal tighening; 2 the same as in 1 , except that GDP is replaced by potential GDP; 3 a reduction of at least 5 percentage points in the debt ratio by the third year after the end of the two-year fiscal tightening.
As we can see in table 2 the public debt as a percent of GDP has been growing steadly since Finally, it is also possible to identify episodes of fiscal stimulus. Following the definitions of a tight fiscal policy, an episode of fiscal stimulus can be defined as period in which the primary structural fiscal balance declines by at least 1.
We have, therefore, two years of loose fiscal policy, and In , we had a surplus of 3. As we can see in the top panel of figure 1 , the Brazilian primary deficits can be modeled as deriving from one of two regimes, which correspond to episodes of fiscal consolidation surpluses or fiscal stimulus deficits , respectively. We can, therefore, decompose the series into a sequence of segmented time trends as in Hamilton The task is to characterize the two regimes and the law that governs the transition between them.
These parameter estimates can be used to infer which regime the process was in at any historical date given that the change in regime is itself a random variable. In this way we can have a more precise method to determine the episodes of fiscal adjustment in Brazil than the informal criteria used before. We can still evaluate if the two methods give similar results.
We are going to consider the primary deficit process in percent of GDP y t to be influenced by an unobserved random variable s t which characterizes the ''state'' or ''regime'' that the process was in at date t. The model for the primary deficit series is then:. It is assumed that the process for s t depends on past realizations of y and s only through s t Once the population parameters are known, it is possible to have the probability that the process was in some particular regime s t at date t on the basis of information available at the time.
This is the ''filter'' inference about the probable regime at date t. It is possible still to use the full sample of ex post available information y 1 , We use monthly data on the actual primary deficit from January to December It would be better to use the adjusted primary deficit in order to have the same series used in the informal analysis.
Besides, although the idea of adjusting fiscal balances makes more sense for years we would not have enough observations to carry on the estimations. However, despite of the fact that a change in fiscal regime requires at least one fiscal year to be characterized, the Government consistently makes several changes in the budget even after it is approved. For example, there are periodic retention of funds devoted to some programs and projects, contingency of some funds, and late approval of others.
The data is obtained from Boletim do Banco Central do Brasil , several issues. Maximum likelihood estimates of parameters are reported in table 3. The estimates also show that each regime is highy persistent. In other terms, these probabilities indicate that if the system is in either state 1 or state 2, it is likely to stay in that state.
The top panel of figure 1 plots the primary deficit in Brazil in percentage of GDP. This inference uses the full sample of observations y 1 , In fact, by our estimates the switches between states are infrequent. We have only two changes in regime. The fiscal policy was in an expansionary state that is, in state 2 from to , and was in a consolidation state state 1 from to The consolidation state from is due basically to three facts. The first, is the effect of inflation on the real value of the expenditures.
As observed before, some funds could be made available later than the established in the budget, implying a loss in real terms. The revenues, on the other hand, were more protected since the taxes were indexed to past inflation. Second, effective adjustments in spending were made. One example is the fact that transfers to the public enterprieses were virtually eliminated. Third, the recovery of the economy after had positive effects on the revenue.
The expansionary state from is due, on the other hand, to two factors. First, an increase in the transfers to states and municipalities. Second, a discretionary increase in expenditures. The Constitution did not determined as mandatory the adjustment of some spendings but they were even though increased. The next question to be answered is whether the size and the composition of fiscal consolidation influences its probability of success.
Giavazzi and Pagano believe that a sharp fiscal contraction could be expansionary, based on expectational effects of fiscal contractions. If large fiscal contractions signal lower future tax burdens, this could increase the expected lifetime disposable income, and in turn increase consumption.
Besides, Giavazzi and Pagano argue that the responses of private consumption are more likely when changes in fiscal policy are large and persistent. Composition of spending cuts may also have important consequences on how permanent the fiscal adjustment is. There are basically two reasons why the composition of adjustments matter Alesina and Perotti, First, different types of spending cuts can be more or less permanent. A reduction in public spending e. On the other hand, cuts in welfare obtained by a change in the eligibility criteria for transfer payments have permanent effects.
Therefore, even if the two types of spending cuts have the same magnitude, the lasting effects are different. Second, governments that are able to cut the politically more delicate components of the budget public employment, social security, welfare programs may signal that they are more committed to a serious fiscal adjustment.
They still call attention for the differences in composition of types of spending and sources of revenue. In unsuccessful cases government wages remain practically unchanged.
Successful adjustments, therefore, imply cuts that include especially the politically sensitive parts of the budget.
Unsuccessful adjustments priviledges cuts in public spending. One reason for this choice is that to the eyes of the voters cuts in public spending are less visible than cuts in wages and pensions. Concerning the composition of tax increases, in successful adjustments tax increases are concentrated in business and indirect taxes. In successful cases, the tax increase is not concentrated in any category. McDermott and Wescott also obtain the same results.
Fiscal consolidations, based on cuts on the expenditure side, especially transfers and government wages, are more likely to succeed in reducing the debt ratio. However, contrary to Alesina and Perotti, they believe that the differences in composition of adjustment are as impressive as the differences in size.
The greater the magnitude of the fiscal consolidation, the more likely it is to be successful because it appears as more credible. Table 3 summarizes the operations of the public sector in Brazil in percent of GDP from to , in order to verify which categories were responsible for the consolidation detected in , and to assess if the adjustment has the typical profile of an unsuccessful adjustment described before. As observed before, the informal criteria pointed out as a consolidation year.
Also, the formal criteria pointed out as a transition year from consolidation to expansion. Therefore, is a good example year to study how the composition of the adjustment affects its success. The following aspects of table 4 call attention:.
In we observe an episode of fiscal consolidation in Brazil that is not successful but that is characterized by a broader adjustment on the expenditure side, contrary to what is observed in most unsuccessful cases where the adjustment is more on the spending side.
Expenditures with goods and services as well as with investments suffer large cuts as would be expected in unsuccessful adjustments. Therefore, the Brazilian fiscal adjustment in matches perfectly the profile of a standard unsuccessful adjustment in what concerns differences in composition of types of spending and sources of revenue.
However, the matching does no longer exist when the size of the adjustment is considered. The largest part of the adjustment was observed on the spending side as in successful cases. This paper tries to give a more accurate picture of the fiscal performance in Brazil over the recent period. Using an informal criteria that includes the magnitude of the adjustment as well as the number of periods that are considered for the changes, is classified as a consolidation year, is classified as an expansion year and is classified as a consolidation year.
When the primary deficit process is modeled as a Markov chain, there is a change in regime in contraction to expansion and in expansion to contraction. The adjustment can be characterized as a type 2 adjustment Alesina and Perotti, in the sense that cuts were made mainly in public investment, while government wages and transfers remained almost unchanged. In the analysis we have focused on the government as a whole.
For further research it would be interesting to investigate the role of local governments during major fiscal adjustments. Evidence on the size and composition of adjustments by states and municipalities would be very helpful to understand the low rate of success of fiscal consolidations in Brazil. Abrir menu Brasil. Revista Brasileira de Economia. Abrir menu. Fabiana Rocha Paulo Picchetti About the authors.
Keywords: fiscal adjustment; magnitude; composition; Markov chain. JEL codes: E62; E This adjustment is characterized by the following: since interest payments cannot be directly influenced by government fiscal policies in the short run, primary deficits are the variables of interest instead of total deficits; it is necessary to remove the component of the government balance that is a result of the business cycle.
Alesina, A. IMF Staff Papers , 44 2 Bevilaqua, A. If they cannot be avoided, they should at least be quickly replaced with better-quality measures. Across-the-board cuts often seem attractive; this approach allows each individual operating ministry to decide how to cut its budget and it appears to imply equal hardship for all. But cuts in dissimilar programs will not have the same economic consequences.
Such cuts can also quickly lead to arrears, add to long-term costs e. In the absence of a more fundamental review, any savings are likely to be reversed sooner or later. Across-the-board cuts in nonwage current spending can result in less funds for highly productive nonwage social sector inputs, such as medicines or textbooks. Spending financed from privatization proceeds may need to be reversed once this one-off source of financing dries up. Financial transactions taxes can drive financial transactions underground, especially if set at relatively high levels.
Fewer financial transactions result in falling revenue yields, the economy loses productivity, and the banking system suffers. This results in lower revenues over the longer term, with the benefits typically accruing to the better-off in society.
Durable expenditure reductions in industrial countries typically involve tackling the wage bill, subsidies, and transfers Alesina and Perotti, Evidence also suggests that emerging market economies with lower subsidies and transfers or higher revenues are more likely to sustain consolidations.
Similarly, developing countries that cut selected current spending while protecting capital expenditures tend to experience longer-lasting adjustment. For countries with low revenue-to-GDP ratios most developing countries , revenue increases can also lengthen the duration of fiscal consolidation Gupta and others, Higher-quality and more durable reforms typically take time to implement and to yield budgetary benefits.
This is true, for example, for broadening the tax base or shifting from trade taxes to broad-based sales taxes, especially when administrative capacity is weak. Civil service reform requires prior groundwork preparation, such as civil service censuses, and may also require severance outlays Box 4.
Such measures should therefore be implemented as part of an overall policy package that provides for an appropriate degree of short-run deficit reduction. Such laws attempt to impose an underlying constraint, of varying degrees of formality, on fiscal policy and often on those that make it. Fiscal responsibility laws can entail numeric rules, such as a balanced budget, or impose procedures focusing on enhancing transparency and accountability. They typically require that the government commit to a monitorable fiscal policy strategy or to specific fiscal targets.
Fiscal responsibility laws generally include explicit escape clauses that suspend their application during exceptional circumstances, such as natural disasters or severe recessions. They can also define fiscal targets in terms of multiyear horizons or structurally adjusted indicators. Civil service reform often plays a central role in fiscal adjustment programs. Such reforms typically aim to reduce high wage bills which they have often failed to do , improve productivity, and lessen incentives for corruption.
A centralized reform strategy is based on a functional review that identifies unnecessary programs and positions. The prerequisites for a successful decentralized reform are a high degree of transparency and accountability. Civil service censuses and functional reviews should precede the design of retrenchment programs. In Cambodia, for example, a civil service census and the fingerprinting and registration of civil servants in all provinces reportedly eliminated thousands of ghost workers.
Civil service wages should be set within the budget process rather than independently by parliament , and monetization and consolidation of benefits should precede reforms of pay structures. In Honduras, for example, before reforming the salary structure, a new wage policy law had to be passed. The law eliminated special wage regimes and gave the ministry of finance rather than congress the power to determine government wage increases. Because in most countries fiscal responsibility laws have not been around for more than a few years, evidence on their effectiveness remains preliminary.
But some tentative lessons seem to be emerging:. Institutions should be sufficiently developed to support the requirements included in the legal framework. Public finance management systems, in particular, should be sufficiently advanced to credibly implement, and enforce, the procedural and fiscal rules. Fiscal responsibility laws require broad political consensus to be successful and are not a substitute for political commitment.
While the adoption of such laws can potentially catalyze meaningful reforms promoting fiscal prudence, experience suggests that broad support for fiscal prudence is a precondition for their success. Designing the framework takes time and should be aimed at addressing country-specific weaknesses in fiscal management that underlie poor fiscal outcomes.
These requirements may not be met in countries facing large macroeconomic imbalances or political instability. Fiscal responsibility laws should cover a broad definition of government.
Those with broader coverage of the public sector tend to be more successful than those more narrowly focused e. In countries with a weak track record of policy implementation, procedural rules may work better than numeric rules. Under these circumstances, procedural rules 21 can often be beneficial by promoting fiscal discipline through increased transparency and accountability.
Numeric fiscal rules, if included, should be carefully designed. Numerical rules can be helpful, for instance, in containing a deficit bias, but they are not in themselves the solution to structural fiscal problems. Numeric fiscal rules can even foster creative accounting and low-quality measures. While fiscal rules have worked in particular cases, the evidence on their effectiveness in improving fiscal outcomes remains tentative. If adopted, fiscal rules should be 1 well-defined regarding the specific fiscal indicator to be targeted, the institutional coverage, and, if any, escape clauses; 2 simple and transparent, to serve as an effective instrument of communication of government policy objectives; and 3 monitorable, so that noncompliance can be easily detected and addressed.
Enforcement mechanisms should be credible and effective. Escape clauses should be reduced to a minimum to ensure the credibility of the process. These frameworks should also define enforcement mechanisms that could include financial or administrative sanctions for responsible government officials.
Fiscal responsibility laws should enhance transparency. Countries with poor transparency and budget procedures are also unlikely to effectively monitor a meaningful quantitative fiscal target or enforce accountability. Fiscal transparency can support fiscal adjustment by contributing to better and more sustainable policies, and by strengthening accountability.
It should contribute to a more balanced adjustment, especially in the short term, since targets can only be set on activities that are reported fairly reliably. Fiscal transparency should make adjustment measures more durable by generating broader public support and understanding; by facilitating donor support through credible assurances about the use of donor funds; and by increasing predictability for, and confidence in, financial markets.
Transparency also makes officials more accountable and reduces the scope for circumventing the declared adjustment effort by, for example, thwarting attempts to shift activities off budget. Parliaments can play a particularly important role in enforcing transparency. Globalization has increased the pressure on, and rewards for, countries to be more transparent and accountable in managing their economies.
It creates incentives for policymakers to reform policies and institutions to enable their countries to benefit from the rising international flows of capital, technology, and information. Increasingly, attracting foreign direct investment and accessing financial markets at reasonable rates requires not only sound macroeconomic policies but also more transparent and accountable public institutions. The code is based on four general principles.
The principle of clarity of roles and responsibilities requires specifying the structure and functions of government, responsibilities within government, and relations between government and the rest of the economy. Public availability of information emphasizes the importance of publishing comprehensive fiscal information at clearly specified times. Open budget preparation, execution, and reporting covers the type of information made available about the budget process. Budget documentation should specify fiscal policy goals, and the macroeconomic framework, and should clearly describe new policies and identify major fiscal risks.
Assurances of integrity stress the quality of fiscal data and the need for independent scrutiny of fiscal information. This includes an external audit by a national audit body and assessment by independent experts of fiscal forecasts, the macroeconomic forecasts on which they are built, and all underlying assumptions. Governance plays a critical role in determining the quality of fiscal adjustment, especially in scaling up expenditure in low-income countries.
Good governance is generally recognized as a core ingredient of successful development. And in an aid environment that increasingly rests on mutual accountability between donors and recipient governments, governance plays a vital role in stimulating and maintaining donor flows. Bernanke , Ben J. Chalk , Nigel A.
Daniel , James , Jeffrey M. Davis , and Andrew M. Alexander , Jeffrey M. Davis , Liam P. Davis , Jeffrey M. Easterly , William , Carlos A. Ebrill , Liam P. Caprio , J.
Fiechter , R. Litan , and M. Pomerleano Washington : Brookings Press , pp. Jain London : Routledge. Heller , Peter , , Who Will Pay? Khan , Mohsin S. Mackenzie , George A. Orsmond , and Philip R. McLure , Charles E. Mintz , Jack M. Brookings Trade Forum , ed. Potter , Barry H. Ter-Minassian , Teresa , ed. Zee , Howell H. All Rights Reserved.
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