Creating More Fiscal Space in Good Times

One of the lessons from recent crisis, according to the Fund;

A key lesson from the crisis is the desirability of fiscal space to run larger fiscal deficits when needed. There is an analogy here between the need for more fiscal space and the need for more nominal interest rate room, argued earlier. Had governments had more room to cut interest rates and to adopt a more expansionary fiscal stance, they would have been better able to fight the crisis. Going forward, the required degree of fiscal adjustment (after the recovery is securely under way) will be formidable, in light of the need to reduce debt against the background of aging-related challenges in pensions and health care. Still, the lesson from the crisis is clearly that target debt levels should be lower than those observed before the crisis. The policy implications for the next decade or two are that, when cyclical conditions permit, major fiscal adjustment is necessary and, should economic growth recover rapidly, it should be used to reduce debt-to-GDP ratios substantially, rather than to finance expenditure increases or tax cuts.

The recipe to create additional fiscal space in the years ahead and to ensure that economic booms translate into improved fiscal positions rather than procyclical fiscal stimulus is not new, but it acquires greater relevance as a result of the crisis. Medium-term fiscal frameworks, credible commitments to reducing debt-to-GDP ratios, and fiscal rules (with escape clauses for recessions) can all help in this regard. Similarly, expenditure frameworks based on long-term revenue assessments help limit spending increases during booms. And eliminating explicit revenue earmarking for prespecified budget purposes would avoid automatic expenditure cuts when revenues fall. A further challenge, as governments come under greater pressure to display improved deficit and debt data and are tempted to provide support to ailing sectors through guarantees or off-budget operations, is to ensure that all public sector operations are transparently reflected in fiscal data and that well-designed budget processes reduce policymakers’ incentives to postpone needed adjustment.

Related;
The Case For Higher Inflation

I would add, however, that there’s another case for a higher inflation rate — an argument made most forcefully by Akerlof, Dickens, and Perry (pdf). It goes like this: even in the long run, it’s really, really hard to cut nominal wages. Yet when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis.

More roles for the World Bank in Africa

Economic policy in Africa in light of the crisis- I would recommend Ali Mansoor's ( Mauritius finance secretary) comments;

• Emphasis on O&M 
  
• Countercyclical social Safety nets
  
• Invest on environment
  
• Mauritius approach to restructuring firms during the crisis
  -IFC needs to be more proactive
  

Shanta has more.

Initial Lessons of the Financial Crisis- IMF

• Not all booms are alikeWhat may matter is not so much the asset price boom in itself, but who holds the assets and the risk, how the boom is financed, and how an eventual bust may affect financial institutions. The degree of leverage associated with the funding of a boom and the degree of involvement of banks and other financial intermediaries will determine the magnitude of balance sheet effects and the dangers to the supply of credit in a bust.

• The case for policy intervention depends on how a boom is financed and how risk is held. Asset price booms supported through leveraged financing and involving financial intermediaries should be dealt with, since they entail risks for the supply of credit to the economy; other booms could more likely be left to themselves.

• The mandate of monetary policy should include macro-financial stability, not just price stability. To the extent that the build up of systemic risk can portend a sharp economic downturn, and to the extent that regulation cannot fully prevent such a buildup, it is now clear that policy makers cannot neglect asset-price and credit booms. That said, prudential measures provide a more targeted and less costly policy solution than interest rate changes and should be a central element of an integrated policy response

• The crisis also highlights two important lessons for fiscal policy. The first is that, in many countries, budget deficits were not reduced sufficiently during the boom years when revenues were high, which limits the fiscal space needed to fight the crisis. The second has to do with the structure of taxation. In most countries, the tax system is biased toward debt financing through deductibility of interest payments. This bias to higher leverage increases the vulnerability of the private sector to shocks, and should be eliminated.

-IMF Executive Board Discusses "Initial Lessons of the Crisis"


Initial Lessons of the Crisis
Initial Lessons of the Crisis for the Global Architecture and the IMF
Lessons of the Global Crisis for Macroeconomic Policy

Lessons of the Financial Crisis for Future Regulation of Financial Institutions and Markets and for Liquidity Management

Video
Press Briefing on Lessons of the Financial Crisis, IMF