Chipping Away at Public Debt

Path-breaking research on one of the most important macroeconomic policy challenges in the post-crisis world, presented in accessible language

Written and researched by a team of experts from the International Monetary Fund, other policy-making institutions, and academia, this timely book looks at fiscal adjustment plans in advanced economies, comparing the planned or projected reductions in debts and deficits to the actual outcomes, and explaining why objectives were met in some cases but missed in others. An overview reveals pitfalls to avoid and lessons learned for securing successful fiscal adjustment.

• Written by experts in the field
• Addresses public concern about skyrocketing government debts
• Contains cutting edge research that changes the way we look at fiscal adjustment
• Presents meticulous archival research in compelling and engaging case studies
• Explores lessons learned and policy implications going forward
• Includes country coverage of all G7 and European Union economies

Educating and informing investors, economists, and the general public, this important book looks at why some attempts to curb debts and deficits succeed whereas others fail, as well as how to ensure successful fiscal adjustment in the period ahead.

Foreword ix

Acknowledgments xi

Introduction xiii

CHAPTER 1 Canada: A Success Story 1
Cemile Sancak, Lucy Qian Liu, and Taisuke Nakata

Introduction 1

Background 2

Plans versus Outcomes: Macroeconomic Factors 7

Nature and Composition of Adjustment 13

Structural Reforms 21

Extent to which Adjustments Were Sustained 23

Conclusion 25

Notes 27

CHAPTER 2 United States: The Quest for Fiscal Discipline 31
Jiri Jonas

Introduction 31

First Attempt: Balanced Budget and Emergency Deficit Control Act 1985 33

Second Attempt: Omnibus Budget Reconciliation Act of 1990 36

Third Attempt: Omnibus Budget Reconciliation Act of 1993 38

Actual versus Projected Fiscal Performance under Omnibus Budget Reconciliation Act of 1993 42

1990s Deficit Reduction: Good Policy or Good Luck? 44

Easy Won, Easy Lost? 50

Conclusion 52

Notes 54

CHAPTER 3 France: Virtue and Fortune 57
Edouard Martin, Irina Tytell, and Irina Yakadina

Introduction: Factors Underlying the Need for Fiscal Consolidation 57

Early Attempts at Fiscal Adjustment 61

A First Attempt at Medium-Term Fiscal Consolidation, 1994–97 64

A More Systematic Approach to Medium-Term Budgeting: Consolidation Experiences under the Stability and Growth Pact 72

Conclusion 81

Notes 82

CHAPTER 4 Germany: Fiscal Adjustment Attempts With and Without Reforms 85
Christian Breuer, Jan Gottschalk, and Anna Ivanova

Introduction 85

1975–79 Consolidation Attempt 88

1981–85 Consolidation Attempt 93

1991–95 Consolidation Attempt 99

2003–07 Consolidation Attempt 105

Lessons 110

Notes 112

CHAPTER 5 United Kingdom: Four Chancellors Facing Challenges 115
Toni Ahnert, Richard Hughes, and Keiko Takahashi

Introduction 115

Selection of Consolidation Plans 116

Background, Content, and Performance of the Four Adjustment Plans 117

Determinants of Success and Failure 125

Lessons from Success and Failure 138

Appendix 5A. United Kingdom: Fiscal Adjustment Plans and Outturns 140

Notes 150

CHAPTER 6 Italy: Medium-Term Fiscal Planning under Frequent Government Changes 153
Fabrizio Balassone, Sandro Momigliano, and Pietro Rizza

Introduction 153

A Brief History of Italy’s Fiscal Planning Framework 155

Short-Term Origins of Medium-Term Failures 157

A Narrative of Design and Performance of Pre- and Post-European Monetary Unit Plans 162

Implementing Plans for the Year Ahead 165

Two Important Plans Analyzed in Detail 167

Conclusion 172

Notes 174

CHAPTER 7 Japan: Fiscal Adjustment Plans and Macroeconomic Shocks 177
Keiko Takahashi and Kiichi Tokuoka

Introduction 177

The 1997 Fiscal Structural Reform Act 178

Medium-Term Fiscal Adjustment Plans: Fiscal Year 2002 and the Following 189

Conclusion 203

Appendix 7A: The Bohn Fiscal Sustainability Test 206

Appendix 7B: Timeline of Medium-Term Fiscal Adjustment Plans in Japan 209

Notes 209

CHAPTER 8 The Performance of Large Fiscal Adjustment Plans in the European Union: A Cross-Country Statistical Analysis 213
S. Ali Abbas, Fuad Hasanov, Paolo Mauro, and Junhyung Park

Introduction 213

Data, Sample Selection, and Methodology 216

Descriptive Analysis 219

Regression Analysis 232

Conclusion 241

Appendix 8A: Data Issues and Cyclical Adjustment 243

Appendix 8B: Timeline for European Monetary Integration (1990–2009) 245

Notes 246

CHAPTER 9 Conclusion 249

Key Findings: What Failed and What Worked in Past Attempts at Fiscal Adjustment 251

Implications for Planned Adjustments 255

Notes 258

References 259

About the Project Team 267

Index 271

"This analytical cross-country study of fiscal adjustment will be highly relevant for several countries, especially those in the euro area that, in the context of the new European governance, will follow a path of public debt reduction in the years ahead."
—Carlo Azeglio Ciampi, Emeritus President of the Italian Republic (President, 1999–2006; Finance Minister, 1996–1999)

"Unfortunately, out of necessity, the issues of debt and deficit dominate the national debate in too many countries. The experience of others can often provide a guide to solutions—what to do and what not to do. In this context, this book will prove invaluable."
—The Right Honorable Paul Martin, former Finance Minister (1993–2002) and Prime Minister (2003–2006) of Canada

"Budget consolidation may well be the defining macroeconomic issue for the industrialized world over the next decade. The budget debate is as unbalanced as the budget. Ideology and rhetoric dominate in places where evidence and logic should dominate. This important book balances the debate by providing careful and analytic evidence on all the important tradeoffs. It is a must-read for everyone concerned about our fiscal future."
—Lawrence H. Summers, University Professor at Harvard University; former Director, National Economic Council (2009–2011); Secretary of the U.S. Treasury (1999–2001)

"Reducing public debt will be the main policy issue for the next decade. This volume greatly helps us understand how to do it in a way that achieves the intended objectives despite unexpected events that will inevitably occur. We don't know as much as we should about fiscal policy: this volume improves our understanding with a careful analysis of many international examples of fiscal adjustment. A great read."
—Alberto Alesina, Professor of Political Economy, Harvard University

"How should countries around the world deal with their burgeoning levels of national debt? This timely book's detailed case studies illustrate that though failure is common, there is also more than one path to success and a number of key principles that can serve as a guide to navigation."
—Alan J. Auerbach, Professor of Economics and Law, Director of the Burch Center for Tax Policy and Public Finance, University of California, Berkeley

"There are few questions more important in the U.S. and Europe today than how public debt will be brought under control. Chipping Away at Public Debt reviews a wealth of experience with large-scale fiscal adjustment plans in advanced economies, drawing on country studies as well as statistical analysis. The authors reach useful and sometimes unexpected conclusions. In particular, economic factors such as 'growth surprises' are perhaps even more important than political factors in determining success."
—Dani Rodrik, Professor of International Political Economy, John F. Kennedy School of Government, Harvard University

PAOLO MAURO is a Division Chief in the IMF's Fiscal Affairs Department. He has published several articles in top economics journals and is coauthor of Emerging Markets and Financial Globalization: Sovereign Bond Spreads in 1870–1913 and Today. The IMF is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world. Its Fiscal Affairs Department provides policy and technical advice on public finance issues to member countries. Chipping Away at Public Debt

The global financial and economic crisis that began in the late 2000s caused the public finances in the world's most advanced economies to experience their most profound worsening since World War II. Government debts as a share of gross domestic product in the G7 countries—Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States—are now higher than in the early 1950s. Spending pressures in the aging-related areas of pensions and, especially, health care will add to the challenge in the years ahead.

Written and researched by experts at the International Monetary Fund (IMF), Chipping Away at Public Debt looks at fiscal adjustment plans in advanced economies, comparing the planned or projected reductions in debts and deficits to the actual outcomes. It also looks at whether spending exceeded, or revenues fell short, of expectations, and why, and whether planned debt reductions proceeded faster or slower than projected. The concluding chapter summarizes lessons learned and provides suggestions for attaining successful fiscal adjustments.

Beginning with a Foreword by Carlo Cottarelli, Director of the IMF's Fiscal Affairs Department, Chipping Away at Public Debt looks at:

• Successful adjustment founded upon reforms in Canada (by C. Sancak, L. Q. Liu, and T. Nakata)

• The quest for fiscal discipline in the United States (by J. Jonas)

• Virtue and fortune in France's fiscal consolidation (by E. Martin, I. Tytell, and I. Yakadina)

• Lessons from past experience in Germany (by C. Breuer, J. Gottschalk, and A. Ivanova)

• Four chancellors facing challenges in the United Kingdom (by T. Ahnert, R. Hughes, and K. Takahashi)

• Italy's medium-term fiscal planning under frequent government changes (by F. Balassone, S. Momigliano, and P. Rizza)

• Japan's fiscal adjustment plans and macroeconomic shocks (by K. Takahashi and K. Tokuoka)

• A statistical analysis of performance in the European Union (by S.A. Abbas, F. Hasanov, P. Mauro, and J. Park)

With fiscal crises having recently begun to affect some advanced economies, there is now a greater realization that the need for fiscal adjustment in the years ahead is at its highest and will no doubt remain a key issue for a long time to come. Required reading whether you are an investor or economist, Chipping Away at Public Debt changes the way we look at large fiscal adjustments, by shifting the focus of empirical analysis to large fiscal adjustment plans, as well as through comparison of plans versus outcomes.

Praise for Chipping Away at Public Debt

"This analytical cross-country study of fiscal adjustment will be highly relevant for several countries, especially those in the euro area that, in the context of the new European governance, will follow a path of public debt reduction in the years ahead." —Carlo Azeglio Ciampi, Emeritus President of the Italian Republic (President, 1999–2006; Finance Minister, 1996–1999)

"Unfortunately, out of necessity, the issues of debt and deficit dominate the national debate in too many countries. The experience of others can often provide a guide to solutions—what to do and what not to do. In this context, this book will prove invaluable." —The Right Honorable Paul Martin, former Finance Minister (1993–2002) and Prime Minister (2003–2006) of Canada

"Budget consolidation may well be the defining macroeconomic issue for the industrialized world over the next decade. The budget debate is as unbalanced as the budget. Ideology and rhetoric dominate in places where evidence and logic should dominate. This important book balances the debate by providing careful and analytic evidence on all the important tradeoffs. It is a must-read for everyone concerned about our fiscal future." —Lawrence H. Summers, University Professor at Harvard University; former Director, National Economic Council (2009–2011); Secretary of the U.S. Treasury (1999–2001)

"Reducing public debt will be the main policy issue for the next decade. This volume greatly helps us understand how to do it in a way that achieves the intended objectives despite unexpected events that will inevitably occur. We don't know as much as we should about fiscal policy: this volume improves our understanding with a careful analysis of many international examples of fiscal adjustment. A great read." —Alberto Alesina, Professor of Political Economy, Harvard University

"How should countries around the world deal with their burgeoning levels of national debt? This timely book's detailed case studies illustrate that though failure is common, there is also more than one path to success and a number of key principles that can serve as a guide to navigation."—Alan J. Auerbach, Professor of Economics and Law, Director of the Burch Center for Tax Policy and Public Finance, University of California, Berkeley

"There are few questions more important in the U.S. and Europe today than how public debt will be brought under control. Chipping Away at Public Debt reviews a wealth of experience with large-scale fiscal adjustment plans in advanced economies, drawing on country studies as well as statistical analysis. The authors reach useful and sometimes unexpected conclusions. In particular, economic factors such as 'growth surprises' are perhaps even more important than political factors in determining success." —Dani Rodrik, Professor of International Political Economy, John F. Kennedy School of Government, Harvard University