For an independent fiscal agency

For an independent fiscal agency

In the wake of the recent economic upheaval, few politicians could ignore the siren’s call to expand public sector spending as a way to boost their image as saviours of the universe.

And with many economists conveniently giving them “intellectual" cover, they engaged in an orgy of new spending that brought large fiscal deficits. For example, the US fiscal deficit is projected to be 12% of the gross domestic product (GDP) for 2010; the UK is forecast for a fiscal deficit of 11% of GDP for the same period.

The accompanying rise in public-sector debt levels has prompted questions about sovereign debt defaults. The US congressional budget office estimates that US public sector debt will be 62% of GDP, up from 40% in 2008, twice its historical average, and will rise to 146% by 2030.

Such high ratios are problematic and there has been a rush to conjure up “exit strategies" from deficit-financed “stimulus" spending. According to International Monetary Fund estimates, a 10 percentage points increase in the debt-to-GDP ratio will cause interest rates to rise by about 0.5 percentage point, pushing up debt-service payments for private firms and households. Similarly, an increase of 10 percentage points in this ratio depresses private investment by about 0.4 percentage point of GDP. Lower private investment leads to slower economic growth by 0.15-0.2 percentage point per year. While the amount may not seem dramatic, its impact will be compounded over many years.

And so it must be admitted that fiscal discipline is hardly endemic to representative democracy, in that popular elections tend to generate incentives for politicians to do the wrong thing. For example, they tend to choose policies with evident and immediate benefits for groups that are electorally active, but that generate long-run costs for most citizens. Similarly, policies with evident and immediate costs, but that might have long-run benefits, will tend to be shunned by political leaders.

Clearly, fiscal decisions have great economic consequences and, at the same time, democratically elected officials tend to make poor policy choices. Thus, alternatives must be found. The proposal here is to establish independent “fiscal boards" to oversee tax and spending policies.

This may seem radical. But many thought the same about suggestions that central banks be independent from the influence of the executive and legislative branches of government. Today, central bank independence is almost universally accepted as a key to macroeconomic stability; it’s a litmus test for political maturity.

Let’s step back. We know policymakers can alter economic conditions through fiscal policies that affect government budgets or monetary policy that change interest rates and, thus, the availability of credit. But when politicians control fiscal and monetary policies, there is a clear temptation to misuse these tools. Politicians up for re-election face the temptation to implement policies to provide an impression of greater economic prosperity. Once an election is over, the short-run gains in political support for incumbents give way to long-term costs in the form of macroeconomic instability.

This is the background for today’s monetary policy autonomy. Public opinion shifted towards favouring central bank independence in the 1970s, since politicians then—in both rich and poor parts of the world— were rightly blamed for monetary policies that led to inflation and boom-bust cycles. In essence, it was learnt that monetary and credit policies have such pervasive impact, and their ill effects can be so pernicious, that political interferences must be minimized. And though the 2008 financial crisis has again thrown up questions about central bank independence, politically directed central banks would have surely done worse in inflating a housing bubble.

Besides the extremes—apartheid and genocide—where radical politics motivated governments to take extreme steps, citizens and policymakers have discovered the community benefits gained from depoliticizing even everyday economic and social life. And so there might be great gains from depoliticizing the formulation of economic policy.

The idea here would be to set up an independent agency to decide upon appropriate fiscal policies, which are guided by the goal of stable, long-term growth. Other objectives would be to target long-term debt to minimize the burden on the economy and future generations.

Such a panel could be empowered to alter tax and spending policies in response to cyclical conditions, after, of course, taking into account structural goals. It could enhance the implementation of budgetary changes that are often delayed in parliamentary committees or held hostage to partisan interests.

For example, we know lower economic activity during a steep recession can be offset by forcing interest rates down or by cutting taxes. If policymakers realize that the eventual impact of the central bank cutting interest rates will take 12-18 months to register on the economy (monetary policy acts with a lag), and that they need to act promptly, they could use fiscal tools. Lowering tax rates has an almost immediate impact on household and business spending. Ordinarily, legislative processes and executive approvals may have required long periods. Now, the independent agency can quickly steer policy and minimize delays in decision making.

Countries seeking robust and sustainable rates of growth, including India, should strongly consider removing politics from decisions about the nation’s fiscal priorities.

Christopher Lingle is an independent economic and political risk consultant. He is research scholar at the Centre for Civil Society in New Delhi and visiting professor of economics at Universidad Francisco Marroquin in Guatemala

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