Transcript of a conference call on the release of the IMF paper on The Role and Modalities of Fiscal Policy in Advanced Economies

September 17, 2013

Washington, D.C.
Tuesday, September 17, 2013

SENIOR IMF OFFICIAL: Good morning, let me just say a few words on introduction. This paper was jointly prepared by the Fiscal Affairs Department and by the Research Department of the IMF. What does this paper do?

The starting point is that in the last few years we have lived through extraordinary times. We have seen the largest recession since the '30s starting in 2008. We have a lot of fiscal activism with fiscal stabilizers in most advanced economies. We have seen also huge monetary expansion including through the purchase of government paper. We have seen crises in advanced economies, economies where for several years there had not been a crisis. And we have seen a surge in public debt which is now reached a level that are closer to the historical peak reached during the Second World War in advanced economies.

And so, the question that this paper tries to address is whether these events and new things that we have seen imply a fundamental change in the way fiscal policy operates, will operate in the future, or in the way we look at fiscal vulnerabilities and how to address them, or whether they are simply justified by the fact that we were living in extraordinary times.

One important question that is key to this paper relates to the issue of fiscal activism. Discretionary stimulus was used in several countries in very significant ways and also the automatic stabilizers who were allowed to operate to an extent that had not been seen before. And the question is, does this change fundamentally the role of fiscal policy in the future? The answer that we give is that in normal times, in normal economic fluctuations, monetary policy together with the use of automatic stabilizers will remain a key tool to control the economic cycle.

The paper notes that perhaps the downsides that were related to discretionary fiscal stimulus were not as large as it was thought. But still there are some downsides related to discretionary fiscal stimulus in normal times. First, because it is difficult, difficult not impossible, to change the course of fiscal policy and especially because there is always the risk of a sort of asymmetry. It is easier to expand fiscal policy than it is to tighten fiscal policy.

So in normal times the paper comes to the conclusion that monetary policy should remain the main tool to control the economic cycle. Of course there will be cases in which discretionary fiscal stimulus will remain important and these will be the cases in which conditions are similar to those that have prevailed in the last few years. Namely, conditions in which monetary policy is not sufficient, is not effective. Perhaps because the monetary policy transmission mechanism is impaired by the condition of the financial system or because the size of the recession, the size of the shock is such that the monetary tools are not sufficient to support economic activity.

Now, how frequent will be the cases in which in the future fiscal policy -- fiscal activism, discretionary fiscal stimulus will still have to be used? We don't know. It depends on how frequent will be the conditions that I just described. How frequent will be the condition with which monetary policy will not be working properly?

Of course, the need to use discretionary stimulus would be lower in countries where automatic stabilizers are higher. And here the paper talks a bit about the possibility of various ways which have been discussed at length in the last few years in the economic literature about the possibility of enhancing, of strengthening, the automatic stabilizers. These automatic stabilizers do not have some of the downsides of fiscal stimulus. The main issue is the reversibility.

The discretionary fiscal stimulus, the reason that it is not reversed and that's why it is a bit more risky than the use of automatic stabilizers. This is perhaps the key issue that is discussed in the paper but there are several other issues.

Let me list some of them before moving to the Q & A part of this conference call. One issue is that more attention will have to be given to possibility of public debt crisis in advanced economies. At one point it appeared that advanced economies were sort of safe bets, any way there was no risk in investing in advanced economies. The developments in the last few years have shown that you can have crises also in sovereign debt markets in advanced economics and public debt has increased a lot in these countries.

Another point is that precisely because we have seen that the shocks to public finances can be larger than what had been experienced before 2007, one implication is that ideally the stock of public debt to be kept at target level in the long run should be lower than what was thought before 2007, in order to allow more room for possible shocks which have proved to be larger than it was thought to be possible before 2007.

Frontloading is another issue. In some cases, frontloading fiscal adjustment will be necessary. These are cases in which fiscal imbalances are particularly large. These are cases when markets have very little confidence and very little patience. And therefore, one has to show results very soon. On the other hand, the paper argues that in many, many cases and I will say in most cases for advanced countries at the moment, a gradual fiscal adjustment based on a medium term plan has some advantages with respect to frontloading. And so, frontloading would not be necessary in these cases.

Another issue relates to the composition of fiscal adjustment. As you know there has been a lot of debate about adjustment based on the spending side versus the revenue side. We are quite pragmatic in this paper. It is clear that in countries with high level of taxation like most advanced countries at the moment, fiscal adjustment will have to be based on cutting spending rather than increasing taxes. But again, there would be cases of countries with relatively lower level of taxations in which it would be appropriate to combine spending cuts with increases in taxation, in tax rate or the elimination of loopholes in taxation, the so-called tax expenditures.

Finally, the paper discusses some institutional aspects of fiscal policies. It notes that fiscal rules are important. They need to be properly designed. More attention needs to be given and allows some flexibility to respond to economic shocks within certain fiscal rules, for example, by targeting the structure of balances rather than headline balances.

We also note, and this is my very last point, we also note that fiscal transparency is not yet sufficient. There have been a number of cases in the last few years in which markets were surprised because not enough information was available about fiscal trends. And so, the international community needs to do more to strengthen the transparency of the fiscal accounts in the world. QUESTIONER: Good morning. I was just wondering how the conclusions you've come to will impact the advice that IMF gives to countries? Do you think that there needs to be a change in what kind of programs the IMF suggests or you know, other changes to the actual policies? Thank you.

SENIOR IMF OFFICIAL: No, I don't think that the paper -- this is a sort of stock taking exercise. I don't think it involves changes with respect to what we've been saying in the last few years. Let me give you one example. We have been arguing for a while that a gradual approach to fiscal adjustment is quite often preferable. We continue to think that this is the case. This paper explains why. It sort of takes stock of our current position. It does not change fundamentally our position.

QUESTIONER: And does the same go for debt sustainability as well in terms of how you advise countries based on whether they should lower their debt and that kind of thing?

SENIOR IMF OFFICIAL: I would say yes. It takes stock of the work that we have done in the last few years in this area. Before the crisis the overall idea was that advanced economies would not be subject to very large shocks. Now, this clearly has not been the case in the last few years. Obviously, this implies that the public finances or the government of a state will also be subject to larger shocks if the economy is hit by a shock, public finances suffer.

And this implies conceptually that if before you were targeting a certain level of public debt, which is not the same across countries, but if you were targeting certain countries a long run level of public debt now you should keep in mind that perhaps it's a good idea to target over the long run a lower level of public debt. But let me underscore here: when we talk about long term goals for the public debt level, given the fact that currently public debt in several of those countries is over 100 percent, 120 percent or higher in some cases, this is something that in any case would be regarded by any standard needing a correction over the medium term.

So again, that's not a major change with respect to what levels are within -- what we have argued in the last few years.

QUESTIONER: Okay. Can I ask just one quick follow-up? What do you think is the most controversial part of your paper? Is there something that, you know, most economists wouldn't agree with?

SENIOR IMF OFFICIAL: No. We try in a way to collect the wisdom that most economists now would support, given the evidence of the last few years. As I said, this paper takes stock and clarifies what we have -- how the views of the world, when I say the world I'm talking about the economic world, the view of the economists have evolved over the last few years.

I don't think that mainstream economists will regard this paper as particularly controversial. Of course, there is always somebody who will disagree.

QUESTION: I was struck, near the back of the paper there's this interesting graph about how much of the run-up in government debt sort of remained unexplained. That, you know, the existing models didn't account for, because it was through contingent liabilities falling off the books or bad projections that suddenly had to be sort of updated and things like that.

I was trying to put that a little more in the context of all the work that the IMF has done in these places, the FSAP and the Article IVs and I'm wondering, do you feel that the Fund sort of got snookered by the information you were being given or did you just not understand the structure of how Fannie and Freddie worked, and how banks in Ireland worked and all that? In other words, was there a structural misunderstanding or did you just not have the information flow when you were doing all of your forensic work in those places?

SENIOR IMF OFFICIAL: Just to clarify, are you referring to the chart –in figure 18 on page 39 or to something else?

QUESTIONER: It's on page -- unanticipated increase in debt equals 26.4 percent. It's on page 39.

SENIOR IMF OFFICIAL: So figure 18 on page 39.

QUESTIONER: Yes, the unexplained 22 percent of total. I mean that's a pretty big, pretty hefty chunk to not have an explanation.

SENIOR IMF OFFICIAL: Yes, I think this is a residual with respect to a number of any other quarter. So you explain 80 percent there is a 20 percent that is due to a number of causes. I will not attach particular relevance to the 20 percent. There are a number of factors that depend on the specific countries.

The general question, however, that I think you are raising is the availability of information. It's clear that there has been evidence over the last few years that the fiscal information available was not sufficient. The obvious case is Greece in which numbers had to be revised, the stock of public debt was found to be larger than initially thought. The deficit was found to be larger than initially thought. There have been other cases like this.

So the paper makes the case that there is a need to transcend fiscal transparency and the availability of the fiscal data. In this respect, at the IMF we have started a new program to improve fiscal transparency. We have started new missions, new fiscal transparency assessment missions that we are piloting and we have conducted in a number or in a small number of countries, including Ireland.

And so, this is done for two reasons. One, to raise the awareness of the issue, first of all, but also to improve the knowledge that the world would have about fiscal developments in specific countries.

QUESTION: And will this go towards making explicit this sort of contingent liabilities? Are you arguing that government will account fully for those funds?

SENIOR IMF OFFICIAL: Yes. Yes, the issue of contingent liabilities is an important one that is discussed in these new fiscal transparency assessments. It has to do with risk and the fact that in addition to having good data about baseline fiscal projections we should also have -- we, financial markets, should have better data about what was happening in case of adverse scenarios, and very few countries at the moment have good assessment of fiscal risks. The number of countries in the world that publish fiscal risk assessments documents is about 10. So it's very small and there is a need to do more in this area.

QUESTIONER: But one last thing to be clear. I'm just wondering about this is connected to some of the contingent liability ties into the too big to fail question and whether there's an implicit guarantee for major banks and things like that. So, can you really ever get to the bottom of this until all that complex of issues is solved and even then you've got the issue of how the political system responds in a crisis.

SENIOR IMF OFFICIAL: Look, it's always in human things there is always a limit and there are always imperfections. What we are saying is that more can be done to improve fiscal transparency.

QUESTION: I'd like to ask you if there is any safe sovereign debt level that was -- use it to be safe and not safe anymore. Is there any threshold that you mentioned for advanced economies?

SENIOR IMF OFFICIAL: I don't like thresholds in general terms. They can be misleading. I think thresholds are a good reference point to start further analysis. In this paper, we do not try to estimate any new threshold which in any case would have to be dependent on the feature of each country. So a number of considerations can be indeed in this respect we have used -- you may be familiar with our Fiscal Monitor.

We have used in our long term scenarios very often a target of 60 percent. But we've always been very careful to say that these are just scenarios. Then the appropriate target depends on the country's circumstances.

The fact that there is or there isn't a threshold is something that involves some nonlinearities when we talk about sort of threshold. It's something that is still controversial in economic leadership. As I said, personally, I’m not a strong supporter of thresholds. Other economists believe that there is points in which some linearities, something nonlinear happens. But this paper, anyway, does not come up with any specific new number.

MR. LAMUCCI: Okay, I remember that you had mentioned the fiscal monitor, the 60 percent with all this say that -- it does depend on the circumstances. Thank you very much.


QUESTIONER: My question relates to the interplay between fiscal and monetary policy. I note the paper raised concerns that monetary policy could become subservient to fiscal policy in the current arrangement. And I'm just wondering what it is that central banks can be doing about this threat? Or how we can avoid a situation of fiscal dominance moving forwards?

SENIOR IMF OFFICIAL: Yes, the paper does make sort of -- it does raise this concern. I think the paper also does provide an answer to this and what is critical is to make sure that any support that the Central Bank gives to the government paper market is not a substitute for fiscal adjustment. It is a complement for fiscal adjustment.

It's something that makes, facilitates the fiscal adjustment itself but it cannot be a substitute for fiscal adjustment. If it were a substitute for fiscal adjustment then the risk is that sooner or later monetary policy would lose its credibility and this would lead to an increase in inflation expectations and in interest rates.

I think it's critical to make this policy of central bank supporting the government paper market viable is that is accompanied by progress in fiscal adjustment within a clear medium term fiscal adjustment plan.

QUESTIONER: Okay. Do we need rules to ensure this or do you think discretion is enough? I understand that you're saying its okay when monetary activism complements fiscal adjustment. I suppose, how can we guarantee that fiscal adjustment happens alongside because often Central Banks are some of the first parties to act in the times of a crisis. So how can you ensure that fiscal adjustment catches up?

SENIOR IMF OFFICIAL: First of all, there is nothing better than actually seeing fiscal adjustment in place and at that point central banks will judge whether their action in support of the government paper market will undermine their credibility or not. So central banks are certainly in a position of assessing whether governments are doing or not certain things.

In addition to this, there are institutional reforms in public financial management to introduction of medium term budgetary frameworks and the introduction of fiscal rules that would guarantee that once the fiscal adjustment process is started continues over time. And this can provide further reassurances to central banks.

QUESTIONER: I was wondering what you make of the recent improvement in advance economies’ economic performance. This paper was written in June I understand and since June we've had a very surprising upswing in most advanced economies which is in the latest World Economic Outlook (WEO) update as well. And in the G20 outlook you provided for ministers. And what does this tell us new about fiscal policy?

SENIOR IMF OFFICIAL: I am afraid I might have to disappoint you on this in the sense that there will come out very soon with our new issue of the WEO, , Fiscal M, and Global Financial Stability Report (GFSR)FSR. In that context we will comment on the developments in the last few months and how these changes, how are views not on fiscal policy in general but what fiscal policy should do at present.

This paper is not about the developments in the last few months. I would ask you to have a bit more patience. In a few weeks we'll publish the WEO, the FM, and we'll discuss exactly these issues.

QUESTIONER: If I may come back just briefly on this, in the WEO of October 2012 the IMF went out very strongly saying that the disappointing performance of advanced economies was largely due to the fiscal consolidation being too early and too fast and suggested that multipliers were a lot higher than previously thought. And I was wondering where does this paper take us from that moment and what is the thinking now?

SENIOR IMF OFFICIAL: This paper, as I said, does not talk about the specific value of multipliers at a certain moment or time. It simply says there have been cases in the last few years where fiscal policy had to be used very actively because monetary policy was not working. And there were particular reasons why monetary policy was not working. In the future monetary policy for normal recessions will remain the main tool to address economic shocks but again there will be cases in which fiscal policy will have to be used.

So the paper does not take any new views about the value of the multiplier. It simply says there will be cases in which fiscal policy in the future will have to be used. But in normal circumstances within the monetary policy should be sufficient.

QUESTIOMER: I'm just slightly concerned that the IMF staff position has changed quite a lot over the last few years on fiscal policy. And if we were to write this up today as sort of a certain view of where the IMF stands, we might find in October at the WEO that it will have changed again. So this is why I'm concerned that I’m just saying not in terms of what your recommendations are now but in terms of your view of fiscal policy, does anything recently still have to change at all? Can we take this as a certain view?

SENIOR IMF OFFICIAL: As I said this is stock taking on what happened in the last five years, let's say. So it does not represent any change with respect from one month to another, from one quarter to another or for even one year to another. It does, however, say that we have seen extraordinary things in the last few years and answer the questions because of these extraordinary things that we've seen, including a very active use of fiscal policy.

Does this change fundamentally the way in the future? The way in which in the future fiscal policy will have to be used? And again, the answer is that there will be cases in which fiscal policy will have to be used in a very active way because monetary policy does not work, which are the same cases in which the last few years monetary policy, some policy had to be used actively. But in normal circumstances monetary policy should be sufficient.

This is something that in a way we have been thinking for a while. We never said it explicitly in this way. So this paper does this. Fills this gap of taking stock of what has happened in the last five years.


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