Fiscal Adjustment in EU Countries: A Balance Sheet Approach

Transcription

1 WP/04/143 Fiscal Adjusmen in EU Counries: A Balance Shee Approach Gian Maria Milesi-Ferrei and Kenji Moriyama

2 2004 Inernaional Moneary Fund WP/04/143 IMF Working Paper Research Deparmen Fiscal Adjusmen in EU Counries: A Balance Shee Approach 1 Prepared by Gian Maria Milesi-Ferrei and Kenji Moriyama Augus 2004 Absrac This Working Paper should no be repored as represening he views of he IMF. The views expressed in his Working Paper are hose of he auhor(s) and do no necessarily represen hose of he IMF or IMF policy. Working Papers describe research in progress by he auhor(s) and are published o elici commens and o furher debae. Several European Union counries have recenly implemened or are envisaging fiscal operaions ha improve budgeary figures bu have no srucural impac on governmen finances. This paper evaluaes some of hese measures using a balance shee approach. In paricular, i examines he degree o which reducions in governmen deb in EU counries has been accompanied by a decumulaion of governmen asses. In he run-up o Maasrich (1997) i finds a srong correlaion beween changes in governmen liabiliies and governmen asses, and larger declines in governmen asses in counries saring from higher public deb levels. JEL Classificaion Numbers: H62, H63 Keywords: Fiscal balance, governmen deb, governmen asses, ne worh Auhors Addresses: gmilesiferrei@imf.org; kmoriyam@umich.edu 1 The firs draf of his paper was wrien while Kenji Moriyama was a summer inern in he European Deparmen. The auhors hank Carlo Coarelli, Jorge Cunha, Philippe de Rougemon, Marc Roovers, and paricipans o an IMF seminar and he 2004 Bank of Ialy conference on Public Deb for useful suggesions, and several IMF colleagues for providing valuable insighs on individual counries fiscal operaions.

3 - 2 - Conens Page I. Inroducion...3 II. Framework of Analysis...4 A. Governmen Balance Shee...4 B. Ne Worh General Governmen Deb, and he Fiscal Balance...5 C. The Valuaion of Public Capial...7 D. The Ineremporal Budge Consrain and Nonsrucural Fiscal Measures...7 III. Classificaion of Nonsrucural Fiscal Measures...8 A. Capial Injecions and Recapializaion...8 B. Special Dividends...9 C. Asse Sales (Privaizaion and Corporaizaion)...10 D. Securiizaion...10 E. Quasi-Fiscal Aciviies...11 F. Off-Budge Iems and Infrasrucure Spending...12 IV. Assessing he Impac of Fiscal Adjusmen on Ne Worh...12 A. Fiscal Trends and Changes in Governmen Balance Shees...13 B. Changes in he Governmen Balance Shee: The Evidence...15 C. Fiscal Imbalances and Oupu Projecions...16 V. Concluding Remarks...17 Tables 1. Fiscal Balances, Deb o GDP Raio, EU Counries...18 Figures 1. Changes in Governmen Asses and Liabiliies, Changes in Governmen Liabiliies and Ne Worh, Changes in Governmen Asses and Liabiliies, Changes in Governmen Liabiliies and Ne Worh, Adjused Change in Public Asses and Iniial Deb, Adjused Change in Public Asses and Iniial Public Deb, Degree of Opimism and Budge Balance...22 Appendix I. The Esimaion of Public Capial...23 References...24

4 - 3 - I. INTRODUCTION Several European Union counries have recenly implemened or are envisaging fiscal operaions ha improve budgeary figures bu have no srucural impac on governmen finances. Anecdoal evidence suggess ha hese nonsrucural measures, ranging from securiizaion of governmen asses o he ransfer of expendiures off budge, have no been used so acively since he run-up o he Maasrich Treay of 1997, and according o some commenaors have cas doubs on he effeciveness of he fiscal consrains inheren in he Sabiliy and Growh Pac. 2 This paper provides an evaluaion of fiscal operaions on public finances using a balance shee approach, which reconciles budgeary flows wih changes in he underlying socks of governmen asses and liabiliies. 3 This approach is useful for wo reasons. Firs, a number of nonsrucural fiscal operaions adoped in EU counries involve asse ransacions, whose proper evaluaion requires racking he evoluion of governmen asses in parallel o he evoluion of liabiliies. Second, his approach allows U.S. o invesigae he degree o which changes in he size of gross public deb in EU counries over he las decade reflec corresponding changes in holdings of governmen asses or underlying improvemens in ne worh. Fiscal operaions, which enail a simulaneous reducion of boh governmen asses and liabiliies, such as, for example, a privaizaion operaion whose proceeds are used o reire governmen deb, conribue o he objecive of reducing he size of he public secor and can be desirable and efficiency-enhancing. An improvemen in ne worh, however, and no jus a symmeric reducion of boh sides of he public secor balance shee, is needed if he objecive is o finance a reducion in fuure axaion or make room for an increase in fuure spending needs. Disinguishing beween hese wo ypes of deb reducion is clearly imporan in order o assess he susainabiliy of public finances. Economiss have long debaed advanages and shorcomings of various indicaors of governmen accouns, as well as he appropriae definiion of he public secor. 4 In paricular, he lieraure has emphasized ha radiional fiscal indicaors, such as he fiscal balance and general governmen deb, may offer an incomplee picure of governmen fiscal operaions because hey do no reflec he evoluion of governmen asses (in addiion o governmen liabiliies); fiscal and quasi-fiscal operaions aking place ouside he domain of 2 Bui, Eijffinger, and Franco (2003) discuss his issue and pu forward proposals o increase ransparency. Eurosa (1998) conains a deailed counry-by-counry lis of defici- or debreducion measures adoped in 1997 whose classificaion was doubful. 3 The new Governmen Financial Saisics Manual (GFSM see IMF 2001) proposes a balance shee approach, which uses he erminology of he Sysem of Naional Accouns 1993 (EC, IMF, OECD, UN and World Bank, 1993, henceforh SNA). Despie a few differences (some of hem will referred o laer), he SNA, GFS, and European Sysem of Accouns (ESA) 95 manuals share he same accouning principles. 4 See, for example, Buier (1990), Blejer and Cheasy (1991), and references herein.

5 - 4 - he general governmen; fuure conracual and nonconracual obligaions of he governmen (such as pension liabiliies); and coningen liabiliies. A balance shee approach has been recommended, by among ohers, Buier (1983). While i can poenially address issues arising from all of he criical areas menioned above, he approach we adop in his paper is designed o handle primarily he firs issue and some aspecs of he second. The public finance lieraure has emphasized ha he incenive o use nonsrucural fiscal measures ofen described as creaive accouning may increase in he presence of fiscal rules, bu here is surprisingly lile heoreical and empirical work on he subjec (see Milesi- Ferrei, 2003). Empirical work in his area is clearly hampered by measuremen problems, and has mosly focused on U.S. saes, ha have clearly defined budge rules. 5 An excepion is Easerly (1999), who argues ha fiscal adjusmen in a number of developing counries wih World Bank and IMF programs relied heavily on running down governmen asses (primarily by reducing public invesmen and expendiure on operaions and mainenance), implying ha he reducion in governmen liabiliies did no necessarily correspond o an improvemen in governmen ne worh. This paper provides direc evidence on wheher changes in general governmen deb in EU counries are accompanied by changes in he opposie direcion in governmen asses. The remainder of he paper is organized as follows. Secion II presens he framework of analysis. Secion III classifies nonsrucural fiscal measures in broad caegories, and discusses several examples aken from European Union counries over he pas few years. Secion IV presens a rough aemp a comparing changes in governmen deb wih underlying changes in governmen ne worh. Secion V concludes. II. FRAMEWORK OF ANALYSIS The balance shee approach we adop is based on he 2001 Governmen Financial Saisics Manual (IMF, 2001). I akes he general governmen as he uni of analysis and focuses on changes in governmen ne worh, an approach ha is paricularly useful for highlighing he budgeary impac of fiscal measures involving asse ransacions. A. Governmen Balance Shee The basic principles of his approach can be briefly summarized as follows: 1. The governmen balance shee is composed of hree elemens: on he asse side, he sock of governmen s nonfinancial asses K (he public capial sock) and he sock of financial asses FA ; on he liabiliy side, he sock of financial liabiliies FL. The ne worh of governmen is given by he difference beween oal asses and 5 Bunch (1991) shows ha U.S. saes wih consiuional deb limis use public auhoriies o circumven borrowing resricions, while von Hagen (1991) and Kiewie and Szakaly (1996) find ha consiuional limiaions peraining only o guaranee sae deb do no affec he oal amoun of deb issued by sae and local public auhoriies.

6 - 5 - liabiliies:w = FA FL+ pk, where p is he value of a uni of public capial. While he valuaion of financial asses and liabiliies is relaively sraighforward, he appropriae valuaion of nonfinancial asses he public capial sock is a much more complex issue, which is furher discussed below (see also Buier (2001)). 2. Changes in he various iems of he balance shee can arise because of ransacions, valuaion effecs and oher changes. 6 Transacions reflec operaions resuling in changes o socks, which are accumulaion or decumulaion of asses and liabiliies caused by muually agreed ineracions beween insiuional unis. In addiion o ransacions, he sock of asses can change because of valuaion effecs (for example, flucuaions in prices or exchange raes), or because of oher changes in he volume of asses, such as changes in classificaion. B. Ne Worh General Governmen Deb, and he Fiscal Balance General governmen gross deb, one of he wo fiscal measures ha he Maasrich crieria and he Sabiliy and Growh Pac refer o, is given by he sum of (a) currency (noes and coins) and deposis, (b) securiies oher han shares (excluding financial derivaives), and (c) loans. I is closely relaed o he sock of gross financial liabiliies FL. Among he differences (which are described in ESA 95) he mos imporan are: he reporing of governmen deb on a consolidaed basis (hus excluding, for example, governmen deb held by social securiy funds); and he exclusion of financial derivaives and oher accouns payable, which are insead par of gross financial liabiliies. From a balance shee perspecive, he fiscal balance B ( ne lending or borrowing ) equals he difference beween ransacions in financial asses and ransacions in financial liabiliies. Therefore, i can be viewed as an indicaor of he financial impac of governmen aciviy on he res of he economy. The relaion beween ne lending or borrowing and he change in he ne worh is summarized by he following ideniy: W FA FL + p K + V = B + p K + V (1) where V represens any change in non-financial and financial asses or liabiliies oher han governmen operaions: for example, flucuaions in prices or exchange raes, and holding gains or losses on asses or liabiliies. The ideniy shows ha ne lending or borrowing is generally differen from a change in he governmen ne worh because i includes ne capial formaion by he governmen and excludes valuaion changes. The laer can be quie imporan, for example for counries ha have a significan share of public deb denominaed in foreign currency. 7 6 For example, changes in classificaion of asses and changes in he qualiy of exising economic asses. 7 In Greece, for example, currency flucuaions implied increases in gross deb much larger han he underlying flow of new governmen borrowing, because of he rend nominal depreciaion of he drachma vis-à-vis parner counry currencies.

7 - 6 - From a flow perspecive, he fiscal balance is he difference beween governmen saving S g g and invesmen I. In urn, governmen saving equals he difference beween revenues and curren governmen expendiures (plus ne capial ransfers), S = + R + r FA + r K G r FL (2) g FA K C FL τ C where G is governmen curren expendiure (inclusive of ne capial ransfers ), τ is oal K ax revenue, R is non-ax, non-ineres revenue, r he rae of reurn on governmen nonfinancial asses, and r ( r ) is he rae of reurn on financial asses (liabiliies). In urn, gross FA FL governmen invesmen is given by: I = p[ K K (1 δ )] (3) G 1 g Governmen invesmen I equals ne fixed capial formaion K plus capial depreciaion δ K. If we add capial depreciaion (consumpion of fixed capial) o curren expendiures 1 in equaion (2), we can express he fiscal balance as he difference beween ne saving and ne invesmen. From he definiion of governmen ne worh i is clear ha governmen deb can decrease even when ne worh does no change. A decline in deb can be accompanied by a reducion in financial asses (for example, a privaizaion operaion), or by a decline in he sock of non-financial public capial (for example, if depreciaion of exising capial exceeds gross capial formaion). 8 Also, a swich in he invesmen paern of public social securiy funds from privae secor insrumens o governmen secor insrumens would imply a decline in general governmen gross deb, bu no in he general governmen s ne financial liabiliies or an improvemen in he governmen s ne worh. 9 Hence, reducions in gross governmen deb are no necessarily associaed wih an improvemen in he governmen s ineremporal budgeary posiion. A similar argumen can be made for improvemens in ne lending, paricularly if obained hrough a reducion in ne public invesmen. Indeed, a number of auhors (such as, for example, Blanchard and Giavazzi (2003)) have suggesed o amend he fiscal balance he SGP refers o by excluding ne invesmen expendiures. Oher auhors, such as Buier (2001) 8 Easerly (1999) provides several examples of illusory fiscal adjusmen underaken by foregoing expendiures on operaions and mainenance. 9 Deb in he Maasrich-based definiion is on a consolidaed basis, i.e., general governmen bond holdings by oher branches of he general governmen are need ou. These include, for example, social securiy funds which are invesed in governmen securiies.

8 - 7 - and Bui, Eijffinger, and Franco (2003) are more criical of fiscal resrains based on he socalled golden rule. 10 C. The Valuaion of Public Capial One of he mos difficul issues in consrucing a governmen s balance shee is he valuaion of public capial. The value of privae capial is equal o he presen discouned value (PDV) of he flow of reurns ha i will generae. However, governmen invesmen is underaken in anicipaion of fuure social reurns, ha may or may no ake he form of a sream of cash paymens (Buier (2001)). I is herefore possible for he cos of invesmen o be higher han he presen value of he fuure sream of financial reurns he projec generaes. In he case in which he fuure sream of ne financial reurns is equal o zero governmen invesmen is equivalen o governmen consumpion from a budgeary poin of view. In his case, an evaluaion of he public secor balance shee a marke prices would aribue o public capial a price equal o zero, so ha governmen ne worh would coincide wih he governmen s ne financial asses. Even when he public capial is markeable (say, a building rened o privae individuals, or a sae-owned enerprise underaking marke aciviy) he sream of reurns ha he governmen earns on he asses may be below he marke rae of reurn, because of he presence of an implici subsidy (below-marke rens, or wages above marke levels in he public enerprise). In his case, evaluaing he impac of a sale operaion on ne worh and on he PDV of fuure ax revenues may yield opposie resuls. For example, suppose ha he governmen sells a building or a public enerprise o he privae secor for a price which is below he marke price (iself given by he capialized value of marke rens). In his case, ne worh formally declines, because according o he ESA 95 manual all asses and liabiliies mus be evaluaed a heir marke price in he governmen balance shee. 11 However, he presen value of fuure axes may sill decline, if he valuaion loss is smaller han he presen discouned value of implici fuure subsidies ha he sale eliminaes. We will discuss he implicaions of valuaion problems for governmen asses in several of he examples below. In pracice, nonfinancial public capial is ypically evaluaed a replacemen cos. D. The Ineremporal Budge Consrain and Nonsrucural Fiscal Measures Governmen solvency requires ha he sum of governmen asses and he presen discouned value of fuure axes equal he sum of ousanding governmen liabiliies and he presen 10 The idea of a separae capial budge has a long and disinguished hisory (see, for example, Musgrave (1939)). 11 The sock of he asses and liabiliies recorded in he balance shee is valued a he marke prices prevailing on he dae which he balance shee relaes (page 197).

9 - 8 - discouned value of fuure spending. In oher words, fuure axes have o equal he difference beween fuure spending and he governmen s ne worh: (4) i i T(1 ) (1 ) 1 i + r G 1 i + r W + + where T measures nonineres revenues, G primary expendiure, and r is he rae of ineres, assumed for simpliciy o be consan over ime and equal across asse caegories. Fiscal measures can have an impac on he governmen s ineremporal posiion in various ways: for example, hey can increase ne worh by reducing presen spending and/or increasing presen axes; or hey can affec fuure ax receips or spending (for example, a decline in fuure ax allowances, or a pension reform ha reduces benefis). A fiscal measure permanenly improves public accouns if i reduces he presen value of fuure axes needed o finance fuure spending and repay exising deb. In his conex, an improvemen in he fiscal balance or a reducion in public deb can be defined as nonsrucural if hey do no reduce he need for fuure axaion. 12 Clearly, a proper classificaion of all fiscal measures along hese lines would be hopelessly complex, as i would have o include he impac of any policy decision ha may affec public accouns in he fuure. The paper insead provides a brief sample of nonsrucural fiscal operaions recenly adoped by EU counries, and heir accouning implicaions. Some of he operaions being described may also reduce he need for fuure axaion, bu only on a one-off basis for example, hey may enail a emporary defici reducion, and/or can be a combinaion of a nonsrucural and a one-off measure. III. A CLASSIFICATION OF NONSTRUCTURAL FISCAL MEASURES This secion presens a classificaion of frequenly adoped nonsrucural fiscal measures in broad caegories; for each caegory, i discusses he appropriae recording in fiscal accouns, highlighing he effecs on he fiscal balance, governmen deb, as well as on ne worh and fuure axes. In several cases, a ruling by Eurosa has changed he iniial accouning of hese measures, wih he consequence of undoing he deb or defici reducion ha he fiscal measure iniially achieved. A. Capial Injecions and Recapializaion The ESA 95 manual (page 61) specifies ha a capial injecion C can be of wo ypes: (a) a capial ransfer, when he governmen, acing for public policy purposes, provides funds o a corporaion wihou receiving financial asses and wihou expecing propery income, (b) a financial ransacion, when he governmen, acing as a shareholder, provides funds and 12 In an analogous fashion, one may define permanen fiscal measures (which permanenly reduce he level of fuure spending or he need for fuure axaion) and one-off measures, which reduce fuure axaion needs, bu only emporarily.

10 - 9 - receives in reurn financial asses of equal value of he paymens, on which i expecs dividends. I follows ha if a capial injecion is made o cover expeced fuure losses, or o cover repeiive losses (perhaps so ha he corporaion can reduce is borrowing coss), i should be recorded as a capial ransfer. 13 In his case, ne worh, public deb, and he budge balance worsen by he same amoun as he ransfer. On he oher hand, when a capial injecion is a financial ransacion, i simply implies a change in asse srucure: an increase in financial asses (formally, an acquisiion of share and oher equiy of public corporaions, recorded in he financial accoun), and a decline in oher asses such as currency and deposis (financial asses) if here is a financial ransfer or fixed capial (non-financial asses) if he ransfer involves a non-financial asse. When he counerpar o he capial injecion is a financial asse (i.e., acquisiion of new shares in he public corporaion), neiher he governmen s ne worh nor he fiscal balance change. When he counerpar is a nonfinancial asse (i.e., change in asse srucure), he governmen ne worh does no change, bu he budge balance improves, because he ransfer of he nonfinancial asse is recorded as negaive public invesmen ( gross fixed capial formaion ). In pracice, some EU counries have aemped o record capial ransfers as financial ransacions, so as o avoid an impac on he fiscal balance, leading o discussions wih Eurosa. For example, in March 2002 Eurosa did no cerify he 2001 budge defici iniially repored by Poruguese auhoriies, in par because of quesions relaed o he proper booking of capial ransfers o public secor enerprises. 14 B. Special Dividends During he run-up o Maasrich, several governmens (including Belgium, Germany, and Ialy) considered booking revenues arising from he axaion of capial gains on heir Cenral Banks gold holdings as reducing he budge defici. In general, special dividends are large and excepional one-off paymens based on accumulaed reserves or holding gains, originaing, for example, from he Cenral Bank or public enerprises ouside of he general governmen secor. 15 According o a January 1998 decision by Eurosa, such proceeds resul in a reducion of he Sae equiy which is a financial ransacion and herefore should have no impac on he budge balance. More specifically, such paymens should be classified as wihdrawals of equiy he posiive amoun of receips is offse by a decline in he equiy held by he general governmen in hese enerprises (or in he Cenral Bank), leaving ne financial liabiliies and he budge balance unchanged. However, receips can be used o 13 This is he case even if shares (or equivalen) are issued (ESA 95 manual page 65). 14 The defici (4.3 percen of GDP) urned ou o be much higher han iniially repored. 15 Regular paymens of dividends are recorded as such and hus couned in ne saving of he general governmen.

11 reduce governmen deb even hough his reducion is accompanied by an equal reducion in he financial asses of he governmen. C. Asse Sales (Privaizaion and Corporaizaion) Sales of nonfinancial asses of he general governmen are classified as negaive gross fixed capial formaion in he capial accoun, and heir proceeds ypically imply an increase in currency and deposis in he financial accoun. In oher words, sales of nonfinancial asses are recorded as negaive invesmen expendiure and herefore improve he budge balance. The impac on he governmen s ne worh depends on he difference beween he marke price p m and he acual sale price p of he asse. The impac on he need for fuure axaion mus be evaluaed aking ino accoun he presen discouned value (PDV) of he sream of (direc and indirec) earnings ha he governmen forgoes wih he sale. For example, K suppose ha he governmen earns a rae of reurn r on he asse, and ha he marke rae of m K m reurn is r. If r < r, he governmen is earning below-marke reurns on he asse; his is equivalen o earning an implici marke rae of reurn and paying an implici subsidy. In his case, he asse sale will lead o a decline in fuure axes as long as he PDV of fuure foregone K r m m earnings is below he sale price ha is, p < p. This can occur even when p < p. De m r faco, he asse sale combines wo feaures: he sale of a nonfinancial asse and he eliminaion of a subsidy. Sales of financial asses (such as privaizaion operaions) do no affec he budge balance, bu only he level of gross governmen deb, in case he privaizaion proceeds are used o reduce i. The line of reasoning for evaluaing heir impac on governmen ne worh and on he need for fuure axaion is analogous o he one for nonfinancial asses. D. Securiizaion The issue here is considerably more complicaed, and depends on he adoped securiizaion schemes. In a ypical securiizaion operaion, he governmen sells asses o a Special Purpose Vehicle (SPV), a company se up by a group of invesors. The SPV finances iself on he marke by issuing bonds (asse-backed securiies, or ABS), which are backed by he flow of receips ha he governmen asses purchased from he governmen generae. In a recen ruling, Eurosa (2002) has esablished crieria for he appropriae recording of securiizaion operaions in governmen accouns. In paricular, he requiremens for he SPV-issued bonds no o be couned as governmen deb are: (a) ABSs have no fuure flows which direcly depend on he aciviy underaken by governmen afer he securiizaion operaions, (b) he risk is compleely ransferred o he SPVs, and (c) he difference beween he sale price and he marke price is below 15 percen. In addiion, Eurosa ruled ha (d) he value of he iniial ransacion mus be recorded according o he upfron paymen made by he SPV o he governmen, wih addiional paymens having an impac on he fiscal balance only a he ime hey occur. As a resul of he Eurosa decision, he Ialian fiscal defici for 2001 was increased by an amoun of 6.8 billion (0.6 percen of GDP), as 3 billion in revenues from he securiizaion of loo receips and he securiizaion of real esae asses worh 3.8 billion were excluded

12 from he calculaion of he 2001 fiscal balance. The firs ransacion involved fuure flows (loo receips) ha depend on governmen aciviy, while for he second he iniial price a which he asses were ransferred o he SPV was only 60 percen of heir value. 16 The Eurosa decision also affeced he defici and deb measures of Ausria and Greece. If he underlying asses being securiized are governmen financial asses, securiizaion has no impac on he governmen s ne worh and he budge balance, bu may lead o a decline in gross governmen deb if he proceeds from he securiizaion are used for ha purpose. Specifically, he operaion will resul in an increase in currency and deposis accompanied by a decline in loans in he financial accoun. This was he case, for example, for par of he securiizaion of claims on unpaid social securiy conribuions underaken by he Ialian governmen (he so-called carolarizzazione credii INPS). If he underlying governmen asses are nonfinancial (such as, for example, real esae holdings), securiizaion sill improves he budge balance because he sale of asses is recorded as negaive gross fixed capial formaion in he capial accoun. Also in his case, gross governmen deb declines if he proceeds from he operaion are used for ha purpose. The impac on governmen ne worh and fuure axaion depends on wo facors: he difference beween he marke price and he sale price of he asse; and he presen value of fuure subsidies (he difference beween marke reurns and he sream of earnings ha he governmen forgoes by selling he asse) ha he sale eliminaes (see sub-secion C above). Finally, in he case of collaeralizing fuure receips (CFR), as was he case for Ialy s securiizaion backed by fuure loery receips, he impac on governmen ne worh is in general negligible i would depend on he difference in borrowing coss beween he governmen and he SPV. The Eurosa ruling of July 2002 esablished ha proceeds from collaeralizing fuure receips should always be reaed as governmen borrowing and herefore have no impac on he budge balance and governmen deb. E. Quasi-Fiscal Aciviies 17 In several European Union counries, public financial insiuions (majoriy-)owned by he general governmen and possibly benefiing from a guaranee from he general governmen, play a role in he financing of projecs. These operaions have no impac on he governmen s 16 In Ialy, a second operaion involving he securiizaion of real esae asses was conduced in 2002, and i was designed o mee he new Eurosa crieria. I yielded 6.6 billion (0.5 percen of GDP), and receips were recorded as negaive capial formaion. 17 Quasi-fiscal aciviies are defined as Aciviies (under he direcion of governmen) of cenral banks, public financial insiuions, and non-financial public enerprises ha are fiscal in characer ha is, in principle, hey can be duplicaed by specific fiscal measures, such as axes, subsidies or oher direc expendiures, even hough precise quanificaion can in some case very difficul. Examples include subsidized bank credi and non-commercial public services provided by an enerprise (page 76 in Manual on Fiscal Transparency, IMF). See also MacKenzie and Sella (1996).

13 ne worh because a guaranee is no couned as a governmen liabiliy (coningen liabiliies are in general recorded off-balance shee). However, he payoffs of public financial insiuions can be refleced in general governmen accouns hrough (a) dividends, (b) wihdrawals of equiy, (c) holding gain in shares and oher equiy in he revaluaion accoun, and (d) he calling of guaranee. The laer, which would be recorded as capial ransfer, payable, would worsen he budge balance, gross governmen deb (acquisiion of loans in he liabiliy side of he financial accoun) as well as ne worh. F. Off-Budge Iems and Infrasrucure Spending The ESA 95 manual regulaes he recoding of ransacions beween he general governmen and public enerprises (Par II) as well as leases, licenses and concessions (par IV). For example, when he governmen makes no regular paymen o he corporaion in cash or in kind, eiher direcly or indirecly, he infrasrucure should be recorded in he corporaion s balance shee during he period of exploiaion. If he governmen has shares (or provides guaranees o liabiliies) of he public corporaions which have infrasrucure or off-budgeary iems on heir balance shees, profiabiliy of he off-budgeary iems and infrasrucure should be refleced on dividends or holding gains (or losses) in shares and oher equiy in he governmen s accouns. Therefore, he effecs of he off-budge operaions on he governmen ne worh accrue only indirecly, hrough his channel. More generally, a shif from direc public invesmen o infrasrucure projecs (co-)financed by he privae secor or by a public enerprise ouside he general governmen budge may have no implicaions for governmen ne worh, bu subsanial implicaions for he governmen budge balance and gross governmen deb. Suppose, for example, ha he projec is no enirely self-financing. If i is underaken by a privae firm, which borrows wih governmen guaranees, governmen oulays would be he flow equivalen of he difference beween he required rae of reurn and he acual rae of reurn on he projec. If he governmen underakes he projec direcly, here would be a large upfron cos (ha would show in he budge balance and gross governmen deb), followed by a sream of fuure revenues, whose presen value would be smaller han he iniial oulays by an amoun equivalen o he subsidies paid o he privae firm in he previous case. IV. ASSESSING THE IMPACT OF FISCAL ADJUSTMENT ON NET WORTH The operaions discussed in he previous secion highligh ha he fiscal arges associaed wih he Maasrich crieria may no always provide reliable informaion on he underlying degree of fiscal adjusmen ha a counry is underaking. However, we only provided examples, and an aggregae quanificaion of nonsrucural fiscal adjusmen based on a comprehensive lis of individual fiscal operaions is oo demanding and goes beyond he scope of his paper. In his secion we approach he characerizaion of fiscal adjusmen from a differen perspecive. Firs, we provide a brief descripion of fiscal rends since 1992 for he 12 EU counries, racking no only public deb and he fiscal balance, bu also he socks of financial and nonfinancial asses, so as o provide a rough esimaes of he evoluion of governmen balance shees. Anecdoal evidence (Eurosa, 1998) suggess ha counries wih a higher

14 deb level have made more exensive use of nonsrucural fiscal measures such as asse sales, privaizaion, securiizaion, and special dividends. We invesigae his issue more sysemaically by sudying wheher high deb counries rely more heavily on asse sales, and he degree o which reducions in governmen deb are refleced in an increase in governmen ne worh, raher han a decumulaion of asses. While selling public asses may iself be a desirable objecive, consisen wih a reducion in he governmen role in he economy, fuure expendiure needs due o populaion ageing, ogeher wih commimens o reduce high ax burdens, highligh he imporance o achieve a reducion in ne governmen liabiliies. Second, we consruc a simple indicaor of opimism abou he fuure and examine wheher his degree of opimism is sysemaically correlaed wih he underlying fiscal posiion. Large fiscal imbalances may be associaed wih a degree of shor-ermism in he conduc of fiscal policy (iself relaed o poliical and insiuional facors), and more myopic governmens are more willing o gamble on fiscal adjusmen by relying on rosy macroeconomic forecass. 18 Boh perspecives are grounded in poliical economy argumens. In poliical economy models, governmens ha discoun he fuure more heavily han oher economic agens end o run larger budge deficis and accumulae governmen deb. In he presence of fiscal rules ha limi he size of permissible budge deficis, more myopic governmens may raionally choose o implemen fiscal measures ha shif revenues from he fuure o he presen. As he discussion of Secion III highlighs, one of he ypical feaures of nonsrucural fiscal measures is ha he governmen ges upfron proceeds a he expense of lower revenues in he fuure he governmen moves is fuure cash flow o he curren period. The incenive o engage in his ype of operaion is sronger he higher he governmen discoun rae. Also, he incenive o use nonsrucural measures depends on how severe is he punishmen for violaing a fiscal rule. We would herefore expec he incenive o be sronger in he runup o Maasrich, when an excessive defici could jeopardize paricipaion in he European Moneary Union, han currenly. A. Fiscal Trends and Changes in Governmen Balance Shees Table 1 shows he cyclically adjused fiscal balance in 1992, 1997, and During he period , he fiscal balance improved in all EU member counries, and he average fiscal defici during he period was considerably lower han during However, in several counries he process of fiscal defici reducion during did no achieve a reducion in he raio of public deb o GDP (Table 2). As we argued earlier, he fiscal balance and gross governmen deb capure only par of changes in, and he level of, governmen ne worh. To invesigae furher how he 18 Hallerberg, Srauch, and von Hagen (2002) discuss poliical economy deerminans of growh and budgeary forecass in Sabiliy Programs. A more chariable inerpreaion is ha governmens ha believe markes are unduly pessimisic abou he counry s growh prospecs run larger fiscal deficis because hey expec fas fuure revenue growh.

15 governmen balance shee evolved during he pas decade, i is necessary o focus on he evoluion of public asses as well. Unforunaely, providing a precise assessmen of changes in he governmen balance shee is hindered by severe daa limiaions, in paricular he dearh of comparable daa on governmen ne worh, and on governmen financial and nonfinancial asses (see he Supplemen o he 2001 Governmen Finance Saisics for a discussion). Daa on gross financial asses for some EU counries is available from he OECD, alhough coverage is no homogeneous. 19 In addiion, some counries publish secoral balance shees which include financial asses and liabiliies of he governmen, and he daa are repored by Eurosa. Alhough coverage from his second source of daa should be more homogeneous and complee, availabiliy is limied o a few counries and years. Comparable daa on general governmen nonfinancial asses are also difficul o obain, and more generally here are severe concepual problems in deermining marke values for a hos of governmen asses. Finally, here are some differences in he recording of gross financial liabiliies across counries, alhough he problems in daa comparabiliy across counries are less severe han for governmen asses. Given daa limiaions, we proceed as follows. For counries for which Eurosa or he OECD repor daa on governmen financial asses, we combine hese daa wih corresponding daa on gross financial liabiliies and wih esimaes of he sock of public capial (consruced using he perpeual invenory mehod see Appendix) o esimae he change in he raio of ne worh o GDP. The change in he raio of ne worh o GDP is given by he change in oal asses (financial and nonfinancial) minus he change in oal liabiliies: w w = fa fa + pk pk ( fl fl ) (5) where lower-case leers indicae raios o GDP. We examine o wha degree changes in he raio of public deb o GDP ( fl fl 1) reflec corresponding changes in he sock of governmen asses fa fa 1+ pk pk 1 or changes in governmen ne worh. We perform his exercise for boh he period and he period We also use a second, indirec mehod o assess changes in he governmen s balance shee. The change in ne worh W is approximaely equal o he sum of ne saving, capial ransfers and valuaion effecs. We use direc measures of governmen ne saving and capial ransfers, and approximae valuaion effecs wih he change in governmen deb induced by exchange rae flucuaions. These effecs are quie subsanial for counries ha have a 19 For example, some counries do no include shares in public enerprises among he general governmen s financial asses. 20 Using he esimaes for he public capial sock consruced by Kamps (2004) yields similar resuls.

16 significan share of deb denominaed in foreign currency (especially prior o EMU). We hen use he esimaed change in ne worh o consruc he variable W γ z = + ( fl fl ) ( pk fl ) Y 1+ γ where Y is nominal GDP and γ is he rae of growh. Manipulaing equaions (5) and (6) i can easily be shown ha z is an upper bound on he gross change in he raio of governmen financial asses o GDP: γ z = fa fa 1+ fa 1+ pk pk 1 > w w 1+ fl fl 1 (7) 1+ γ We use equaion (6) o esimae z for he counries for which we don have daa on governmen financial asses (namely Greece, Ireland, Luxembourg, and Porugal). For he oher counries, we can calculae z direcly using equaion (7). We hen relae z o he iniial level of governmen deb, boh for he period and for he period This comparison provides some informaion on he exen o which fiscal adjusmen (as measured by a reducion in gross governmen deb) has lowered he need for fuure axaion. 21 B. Changes in he Governmen Balance Shee: The Evidence The empirical analysis shows subsanial differences beween evens in he pre- and pos- Maasrich period. As shown in Figure 1, he change in public deb beween 1992 and 1997 is srongly posiively correlaed wih changes in governmen asses during he same period, while i is weakly correlaed wih changes in ne worh (Figure 2). Hence, during his period, he evoluion of gross public deb provides only limied informaion on changes in he governmen s ineremporal posiion. Despie a decline in he sock of public asses in he majoriy of counries, beween 1992 and 1997 ne worh deerioraed in all EU counries, excep for Sweden. 22 However, for he period he link beween he change in governmen asses and liabiliies virually disappears (Figure 3), wih changes in gross financial liabiliies srongly correlaed wih changes in ne worh (Figure 4). In erms of general rends, his period is characerized by an improvemen in ne worh in mos counries, nowihsanding generally declining governmen asses. (6) 21 This is of course no a complee measure of he impac of fiscal policy on fuure ax oulays. For example, a pension reform has no impac on ne worh and governmen deb bu can reduce or increase fuure spending, and hence fuure axes. 22 A weak cyclical posiion in several euro-area counries conribued o he unfavorable deb dynamics.

17 In Figure 5 we relae a proxy for he change in he raio of public asses o GDP during he period , consruced according o equaion (6), o public deb a he beginning of ha decade. The Figure shows ha counries wih larger governmen deb in he early 1990s reduced heir financial asses more subsanially in he period han counries wih lower iniial public deb. 23 Once again, he link is much weaker in he period (Figure 6). Overall, hese resuls are consisen wih he noion ha during he period leading up o 1997 governmens conained he rise in he public deb raio (or reduced i) by decumulaing governmen asses, and ha his decumulaion was sronger in counries wih large public debs. During he period insead governmen deb declined and ne worh improved in virually every counry. While more favorable cyclical condiions during he period relaive o he preceding one help explain he improvemen in ne worh, a possible inerpreaion of he weaker incenive o use nonsrucural measures is ha fiscal rules are less punishing in he pos-1997 era (once counries are inside he euro area). A comparison wih he evoluion of balance shees in oher OECD counries can provide some perspecive on wheher we are capuring phenomena associaed wih he esablishmen of budge rules in he euro area and he EU, or common fiscal rends in advanced economies. Preliminary evidence shows ha he correlaion beween changes in financial asses and financial liabiliies for he period is much sronger in he euro area han in noneuro area OECD counries (0.8 versus 0.3). 24 In he subsequen period, he correlaion for euro-area counries drops o zero, while he one for oher OECD counries remains broadly unchanged. C. Fiscal Imbalances and Oupu Projecions The las piece of evidence we focus on relaes o he link beween he growh forecass of counries medium-erm fiscal plans and heir iniial fiscal condiions. Inuiively speaking, given oher condiions, a governmen ha expecs more favorable economic condiions in he fuure and faces consrains on is budge balance and/or deb level has a sronger incenive o use nonsrucural fiscal measures, being on he possibiliy of favorable fuure condiions o avoid he cos of improving he underlying fiscal accouns. Our indicaor of governmen opimism wih regard o oupu is consruced from he period 1998-onwards using he Sabiliy Programs, which are annually submied o he European Commission by 12 EU member counries. These programs repor he forecas of oupu growh on which budgeary projecions are based. We define he degree of opimism abou fuure (DOF) as follows. 23 The correlaion is sronger for he counries ha joined he euro area. 24 In addiion o Denmark, Sweden, and he Unied Kingdom, he non-euro area sample includes Ausralia, Canada, Iceland, Japan, New Zealand, and he Unied Saes.

18 s G + y DOF = 2 s= 1 ( G + s y CF where is he expeced GDP growh rae (annual base) of year +s in he Sabiliy s Program submied a year and CF + y is he expeced GDP growh rae in year +s in he Consensus Forecas in he same monh as he Program was submied. 25 The larger DOF is, he more opimisic he governmen is abou economic condiions in he fuure compared o he Consensus Forecas, which is he simple average of expeced growh raes provided by privae research insiues. For he purpose of cross-counry comparisons, we normalize DOF using he average GDP growh rae from 1993 o 1997 because counries wih high growh rae end o have larger absolue values of DOF. 26 Figure 3 plos he relaion beween he average of he degree of opimism abou he fuure from 1998 o 2001 and he average budge defici per GDP from 1995 o 1997 (resuls are idenical if we use he average budge defici from 1993 o 1995). The negaive correlaion beween he iniial budge defici per GDP and he degree of opimism abou he fuure is sriking among EU counries, governmens wih larger budge deficis have sysemaically more opimisic oupu forecass. These findings are consisen wih he noion ha shorermism in he conduc of fiscal policy, which can lead o larger fiscal imbalances, may also make governmens more willing o rely on opimisic macroeconomic forecass, raher han on upfron fiscal adjusmen. + s y ) V. CONCLUDING REMARKS In he presence of fiscal rules consraining he size of he fiscal balance of he pah of governmen deb, governmens may adop measures ha affec hese arges bu have no impac on he governmen s ne worh. Anecdoal evidence suggess ha hese measures have been widely used in EU counries in he run-up o he adopion of he common currency and also during he curren slowdown. This paper has reexamined fiscal adjusmen in EU counries over he pas decade by focusing on he evoluion of he general governmen balance shee. I has described a number of fiscal measures ha improve he fiscal accouns subjec o he Maasrich crieria bu have no durable impac on public finances as a whole. Empirical evidence for EU counries suggess a posiive correlaion beween changes in governmen liabiliies and changes in governmen asses for he period , bu a much weaker correlaion for he period Also, counries wih a more difficul fiscal siuaion have used sysemaically more opimisic oupu projecions in heir Sabiliy Programs. 25 The Consensus Forecas monhly repors he average of he expeced GDP growh raes (annual base) compued by privae research insiuions in each counry (here is no repor for Luxembourg). 26 Our resuls are robus o differen normalizaion mehods.

19 Table 1. Fiscal Balances, Average Fiscal Balance Cyclically-Adjused Balance Ausria Belgium Denmark Finland France Germany Greece Ireland Ialy Luxembourg n.a. n.a. n.a. Neherlands Porugal Spain Sweden Unied Kingdom Source: OECD, Economic Oulook Table 2. Deb o GDP Raio, EU Counries Ausria Belgium Denmark Finland France Germany Greece Ireland Ialy Luxembourg Neherlands Porugal Spain Sweden Unied Kingdom Source: OECD, Economic Oulook

20 Figure 1. Changes in Governmen Asses and Liabiliies, Change in asses (percen of GDP) Belgium Denmark Ialy Finland France Germany Ausria Sweden Unied Kingdom Spain y = 0.73x R 2 = Neherlands Change in liabiliies (percen of GDP) 0 Figure 2. Changes in Governmen Liabiliies and Ne Worh, Change in ne worh (percen of GDP) Denmark -5 Belgium -10 Ausria Finland Ialy -15 Sweden Spain Neherlands Germany -20 y = -0.27x R 2 = 0.28 Unied Kingdom France Change in liabiliies (percen of GDP) Source: Auhors calculaion based on OECD, Economic Oulook, and Eurosa daa.

21 Figure 3. Changes in Governmen Asses and Liabiliies, Finland 15 Change in asses (percen of GDP) Sweden Belgium Spain Neherlands Denmark Ialy Unied Kingdom y = -0.09x R 2 = 0.01 France Porugal* Germany -10 Ausria Change in ne worh (percen of GDP) Change in liabiliies (percen of GDP) Figure 4. Changes in Governmen Liabiliies and Ne Worh, Sweden Belgium Denmark Neherlands Spain Ialy Finland Unied Kingdom y = -1.06x R 2 = 0.66 France Porugal* Germany Ausria Change in liabiliies (percen of GDP) Source: Auhors calculaion based on OECD, Economic Oulook, and Eurosa, New Cronos daabase.

22 Figure 5. Adjused Change in Public Asses and Iniial Deb, Change in asses, (perc. of GDP) Finland Spain y = -0.17x R 2 = 0.23 France Germany Luxembourg Sweden Unied Kingdom Denmark Greece Ausria Porugal Neherlands Ialy Ireland Belgium Governmen deb in percen of GDP (avg ) Figure 6. Adjused Change in Public Asses and Iniial Public Deb, Finland Change in asses (pc. of GDP) Luxembourg France Denmark Unied Kingdom Germany Porugal Spain Neherlands Sweden Ireland Ausria Greece y = -0.07x R 2 = 0.03 Belgium Ialy Governmen deb in percen of GDP (avg ) Source: Auhors calculaions based on OECD, Economic Oulook, and Eurosa, New Cronos daabase.

23 Figure 7. Degree of Opimism and Budge Balance Growh forecas (deviaion from Consensus) Greece Ialy y = -0.26x R 2 = 0.59 Spain France Porugal Germany Belgium Finland Ausria Neherlands Ireland Average budge defici, (percen of GDP) Noe: he deviaion of he growh forecas from consensus is consruced as follows. Firs, for each year = , we calculae deviaions of he growh forecas incorporaed in he counry s Sabiliy Program from he Consensus growh forecas a he ime he Sabiliy Program was issued, and sum hese deviaions for he years +1 and +2. The resuling deviaions are hen averaged over he period , and normalized by he counry s average growh rae during he period Source: Individual counries Sabiliy Programs and Consensus Forecass.

24 APPENDIX I The Esimaion of Public Capial The paper makes use of he perpeual invenory mehod (PIM) o compue he nominal value of public capial. This appendix derives he formula used in he PIM. The law of moion of real public capial sock is given by, K ( δ K + I (8) = 1 ) 1 where δ represens he real depreciaion rae, which is se o 4 percen. Le he deflaor of he governmen gross fixed capial formaion be p. Muliplying p o boh sides of he above equaion and rearranging gives he following law of moion of nominal public capial. p p K = ( 1 δ ) pˆ p 1K 1 + p I, and p ˆ =. p 1 Le he nominal value of capial be K ~. The new law of moion is finally reduced o, ~ ~ ~ K (1 δ ) pˆ K I. = 1 + This is he law of moion of nominal public capial used o esimae he daa of public capial in our paper. One problem in he PIM is he compuaion of he iniial capial sock, which is usually esimaed based on srong assumpions. In his paper, we implicily assume ha each economy s sock of public capial was in seady sae in he 1980s. Under his assumpion, he iniial level of public capial can be obained as follows. Firs, divide boh side of he nominal law of moion by nominal GDP Y ~ ~ K ~ ~ K (1 δ )(1 + π ) K I ~ = ~ 1 + ~, Y 1+ g Y 1 Y ~ K p K Y where 1+ π = ˆ p = and 1+ g = ~. p 1 Y 1 Hence, in he seady sae, ~ ~ (1 + g) I K = K K g π + δ (1 + π ) where all variables are he average of he 1980s.