Economic Preparedness: The Need for Fiscal Space

IMF Blog, June 27, 2018

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Authors: Vikram Haksar, Marialuz Moreno-Badia, Catherine Pattillo, Murtaza Syed
Publication date: June 27, 2018
Context: IMF staff developed a new framework for measuring fiscal space and tested it during 2017-2018 across a number of Article IV consultations.

Definition: Fiscal space is an estimate of “the amount of room countries have for temporarily increasing their budget deficits without jeopardizing their access to markets or the sustainability of their debt.”
Key considerations in the IMF framework:
- Composition and trajectory of public debt
- Financing needs and ease of borrowing
- Assets that can be drawn upon
- Future spending commitments
- Effectiveness of fiscal policy
- Strength of fiscal institutions
- Existence and design of fiscal rules, including the need for rules to be well designed and regularly reviewed
Characteristics:
- Fiscal space is not determined just by a country’s level of public debt.
- Fiscal space is not static; it can vary with market and economic conditions, sometimes quickly and substantially.
- A well-executed fiscal stimulus can produce a dynamic boost to economic activity that may improve the public debt-to-GDP ratio over time, thereby creating additional fiscal space.
Output: The framework yields an assessment of the degree of fiscal space for a country at a given time, built around four stages (illustrated in an accompanying video on the source page).

Countries cited as having substantial fiscal space:
- Australia
- Germany
- The Netherlands
- Sweden
Reasons cited for substantial fiscal space:
- Access to stable and cheap funding from financial markets
- Healthy public finances
- Strong institutions
Countries cited as having severely constrained fiscal space:
- Brazil
- Italy
- Pakistan
Reasons cited for constrained fiscal space:
- Elevated risks related to funding from financial markets
- Relatively high levels of debt, financing, or debt servicing needs
- Risk of loss of market access if attempting active fiscal policy
Countries with some but not extensive fiscal space:
- China
- The Philippines
- Thailand
- Russia
- Saudi Arabia
- The United States
Rationale for intermediate assessments: Risks to funding or debt sustainability are not severe, but space is limited.

Distinction emphasized:
- Having fiscal space ≠ obligation to use it.
- Fiscal space is like “money in the bank”: it can be drawn upon in times of need but should not be used recklessly.
Decision criteria for using fiscal space (outside the framework):
- Separate cost-benefit analysis
- Whether there is a legitimate need best met through fiscal policy rather than other measures
- Adequacy of existing space given the risks the economy faces
IMF policy advice examples:
- Fiscal consolidation recommended in all countries with limited fiscal space.
- Fiscal consolidation also recommended in several countries with some or substantial fiscal space when economies were in relatively strong positions or needed to rebuild buffers.
- Use of fiscal space recommended where a strong case existed:
- Support of longer-term growth in Germany, the Netherlands, the Philippines, and Thailand
- To offset some potential costs from a needed phase of strong structural reforms in China
- To allow a slower pace of fiscal adjustment for some oil producers

The IMF’s road map for assessing fiscal space is intended to:
- Provide the Fund’s membership with a regular sense of their room for maneuver
- Assist countries in making appropriate policy choices tailored to their individual circumstances

Source: Economic Preparedness: The Need for Fiscal Space (IMF blog, June 27, 2018).