Chipping Away at Public Debt: Sources of Failure and Keys to Success in Fiscal Adjustment

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

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

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.

"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