Fiscal adjustment
Encyclopedia
A fiscal adjustment is a reduction in the government primary budget deficit
, and it can result from a reduction in government expenditures, an increase in tax revenues, or both simultaneously.
There is no a clear consensus about the definition of fiscal adjustment, but it is commonly understood as a process, instead of as a status: governments run fiscal deficits, fiscal surpluses or balanced budgets, and the process from a budget deficit to a sustained period of balanced budget is a fiscal adjustment.
There are two significant features in any fiscal adjustment: the duration of the process, usually measured in years, that defines the intensity of the effort; and the composition of the adjustment, measured as the proportion of the adjustment obtained from expenditure cuts compared to the proportion gained from tax increases.
and to accede to the Economic and Monetary Union
(EMU). The treaty established that any country acceding to the Euro area
should keep his government primary budget deficit below the line of three percent, and the first assessment was established for 1997.
The empirical research found that European governments adopted multiple strategies during the 1990s to fulfill the fiscal prerequisites for EMU accession. It concluded that the ideology
of the party in government became the most powerful predictor of fiscal policies and strategies of adjustment. Evidence shows that in the new context, socialist
governments preferred to use balanced budgets to finance supply-side policies
of capital formation and to maintain public employment
, and are reluctant to cut these expenditures even at the expense of public consumption and transfers. In a most broader analysis of the period, from the 1970s to the present, results confirmed the hypotheses that, besides economic conditions, fragmentation of decision-making, ideology of the party in government, and closeness to elections affect fiscal policy in general and adjustment strategies in particular.
experienced a dozen of years of continuous economic depression during the 1980s, known as the lost decade
, in which hyperinflation
episodes were common. One of the most pressing issues was to manage the debt burden. And, to this end, during this period, the economic policies of Latin American countries evolved from import substitution industrialization to a flawed version of neoliberal economics
, sponsored by some international financial institutions like the World Bank
or the International Monetary Fund
(IMF), and also known as the Washington Consensus
, that advocated for fiscal discipline and for a tax reform
based on a flattering of the tax curve (lowering the tax rates on proportionally high tax brackets, and raising the tax rates on the proportionally low tax brackets).
The IMF designed structural adjustment
policies that advocated for fiscal adjustments based on expenditure cuts, because they usually included, among other conditionalities:
But, despite the words of a prominent supply-side economist, Robert Mundell
, who stated that "fiscal discipline is a learned behavior", there is no economic reason to tie the hands of politicians to tight constantly balanced budgets, because it is possible to keep fiscal discipline along the time, balancing deficits and surpluses according to the business cycle
, as Neo-Keynesian Economics
supports. In fact, many developed nations, including the United States, Germany
, France
or Italy
, carried out neo-Keynesian fiscal policies during the recession of 2002.
Primary deficit
Primary deficit is the deficit which is derived after deducting the interest payments component from the total deficit of any budget.In other words the total of primary deficit and interest payments makes up the total or fiscal deficit...
, and it can result from a reduction in government expenditures, an increase in tax revenues, or both simultaneously.
There is no a clear consensus about the definition of fiscal adjustment, but it is commonly understood as a process, instead of as a status: governments run fiscal deficits, fiscal surpluses or balanced budgets, and the process from a budget deficit to a sustained period of balanced budget is a fiscal adjustment.
There are two significant features in any fiscal adjustment: the duration of the process, usually measured in years, that defines the intensity of the effort; and the composition of the adjustment, measured as the proportion of the adjustment obtained from expenditure cuts compared to the proportion gained from tax increases.
Fiscal adjustments in Europe
European countries experienced intense processes of fiscal adjustment during the 1990s, in order to match the Maastricht criteriaMaastricht Treaty
The Maastricht Treaty was signed on 7 February 1992 by the members of the European Community in Maastricht, Netherlands. On 9–10 December 1991, the same city hosted the European Council which drafted the treaty...
and to accede to the Economic and Monetary Union
Economic and Monetary Union of the European Union
The Economic and Monetary Union is an umbrella term for the group of policies aimed at converging the economies of members of the European Union in three stages so as to allow them to adopt a single currency, the euro. As such, it is largely synonymous with the eurozone.All member states of the...
(EMU). The treaty established that any country acceding to the Euro area
Eurozone
The eurozone , officially called the euro area, is an economic and monetary union of seventeen European Union member states that have adopted the euro as their common currency and sole legal tender...
should keep his government primary budget deficit below the line of three percent, and the first assessment was established for 1997.
The empirical research found that European governments adopted multiple strategies during the 1990s to fulfill the fiscal prerequisites for EMU accession. It concluded that the ideology
Ideology
An ideology is a set of ideas that constitutes one's goals, expectations, and actions. An ideology can be thought of as a comprehensive vision, as a way of looking at things , as in common sense and several philosophical tendencies , or a set of ideas proposed by the dominant class of a society to...
of the party in government became the most powerful predictor of fiscal policies and strategies of adjustment. Evidence shows that in the new context, socialist
Social democracy
Social democracy is a political ideology of the center-left on the political spectrum. Social democracy is officially a form of evolutionary reformist socialism. It supports class collaboration as the course to achieve socialism...
governments preferred to use balanced budgets to finance supply-side policies
Supply-side economics
Supply-side economics is a school of macroeconomic thought that argues that economic growth can be most effectively created by lowering barriers for people to produce goods and services, such as lowering income tax and capital gains tax rates, and by allowing greater flexibility by reducing...
of capital formation and to maintain public employment
Civil service
The term civil service has two distinct meanings:* A branch of governmental service in which individuals are employed on the basis of professional merit as proven by competitive examinations....
, and are reluctant to cut these expenditures even at the expense of public consumption and transfers. In a most broader analysis of the period, from the 1970s to the present, results confirmed the hypotheses that, besides economic conditions, fragmentation of decision-making, ideology of the party in government, and closeness to elections affect fiscal policy in general and adjustment strategies in particular.
Fiscal adjustments in the United States
See U.S. monetary and fiscal experienceFiscal adjustments in Latin America
Due to a combination of factors, including previous debt-based development policies, high interest rates, high oil prices and a decline in the terms of trade Latin American countriesLatin America
Latin America is a region of the Americas where Romance languages – particularly Spanish and Portuguese, and variably French – are primarily spoken. Latin America has an area of approximately 21,069,500 km² , almost 3.9% of the Earth's surface or 14.1% of its land surface area...
experienced a dozen of years of continuous economic depression during the 1980s, known as the lost decade
La Década Perdida
"La Década Perdida", meaning "the lost decade", is a designation to the financial period of crisis in Latin America during the 1980s...
, in which hyperinflation
Hyperinflation
In economics, hyperinflation is inflation that is very high or out of control. While the real values of the specific economic items generally stay the same in terms of relatively stable foreign currencies, in hyperinflationary conditions the general price level within a specific economy increases...
episodes were common. One of the most pressing issues was to manage the debt burden. And, to this end, during this period, the economic policies of Latin American countries evolved from import substitution industrialization to a flawed version of neoliberal economics
Neoliberalism
Neoliberalism is a market-driven approach to economic and social policy based on neoclassical theories of economics that emphasizes the efficiency of private enterprise, liberalized trade and relatively open markets, and therefore seeks to maximize the role of the private sector in determining the...
, sponsored by some international financial institutions like the World Bank
World Bank
The World Bank is an international financial institution that provides loans to developing countries for capital programmes.The World Bank's official goal is the reduction of poverty...
or the International Monetary Fund
International Monetary Fund
The International Monetary Fund 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...
(IMF), and also known as the Washington Consensus
Washington Consensus
The term Washington Consensus was coined in 1989 by the economist John Williamson to describe a set of ten relatively specific economic policy prescriptions that he considered constituted the "standard" reform package promoted for crisis-wracked developing countries...
, that advocated for fiscal discipline and for a tax reform
Tax reform
Tax reform is the process of changing the way taxes are collected or managed by the government.Tax reformers have different goals. Some seek to reduce the level of taxation of all people by the government. Some seek to make the tax system more progressive or less progressive. Some seek to simplify...
based on a flattering of the tax curve (lowering the tax rates on proportionally high tax brackets, and raising the tax rates on the proportionally low tax brackets).
The IMF designed structural adjustment
Structural adjustment
Structural adjustments are the policies implemented by the International Monetary Fund and the World Bank in developing countries. These policy changes are conditions for getting new loans from the International Monetary Fund or World Bank, or for obtaining lower interest rates on existing loans...
policies that advocated for fiscal adjustments based on expenditure cuts, because they usually included, among other conditionalities:
- Cutting social expenditure,
- Removing price controls and state subsidies,
- PrivatizationPrivatizationPrivatization is the incidence or process of transferring ownership of a business, enterprise, agency or public service from the public sector to the private sector or to private non-profit organizations...
, or divestiture of all or part of state-owned enterprises.
Additional evidence
According to some empirical research by economists at this institution, expenditure-based fiscal adjustments were more stable and durable than revenue-based strategies during the 1980s in Latin American and African countries running structural adjustment programs.But, despite the words of a prominent supply-side economist, Robert Mundell
Robert Mundell
Robert Mundell, CC is a Nobel Prize-winning Canadian economist. Currently, Mundell is a professor of economics at Columbia University and the Chinese University of Hong Kong....
, who stated that "fiscal discipline is a learned behavior", there is no economic reason to tie the hands of politicians to tight constantly balanced budgets, because it is possible to keep fiscal discipline along the time, balancing deficits and surpluses according to the business cycle
Business cycle
The term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years...
, as Neo-Keynesian Economics
Neo-Keynesian Economics
Neo-Keynesian economics is a school of macroeconomic thought that was developed in the post-war period from the writings of John Maynard Keynes. A group of economists , attempted to interpret and formalize Keynes' writings, and to synthesize it with the neo-classical models of economics...
supports. In fact, many developed nations, including the United States, Germany
Germany
Germany , officially the Federal Republic of Germany , is a federal parliamentary republic in Europe. The country consists of 16 states while the capital and largest city is Berlin. Germany covers an area of 357,021 km2 and has a largely temperate seasonal climate...
, France
France
The French Republic , The French Republic , The French Republic , (commonly known as France , is a unitary semi-presidential republic in Western Europe with several overseas territories and islands located on other continents and in the Indian, Pacific, and Atlantic oceans. Metropolitan France...
or Italy
Italy
Italy , officially the Italian Republic languages]] under the European Charter for Regional or Minority Languages. In each of these, Italy's official name is as follows:;;;;;;;;), is a unitary parliamentary republic in South-Central Europe. To the north it borders France, Switzerland, Austria and...
, carried out neo-Keynesian fiscal policies during the recession of 2002.
Further reading
- Deficit Reduction: Lessons from Around the World, Committee for a Responsible Federal Budget
See also
- Fiscal discipline
- DebtDebtA debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
- Government budget deficit
- Structural adjustmentStructural adjustmentStructural adjustments are the policies implemented by the International Monetary Fund and the World Bank in developing countries. These policy changes are conditions for getting new loans from the International Monetary Fund or World Bank, or for obtaining lower interest rates on existing loans...
- Supply-side economicsSupply-side economicsSupply-side economics is a school of macroeconomic thought that argues that economic growth can be most effectively created by lowering barriers for people to produce goods and services, such as lowering income tax and capital gains tax rates, and by allowing greater flexibility by reducing...
- Neo-Keynesian EconomicsNeo-Keynesian EconomicsNeo-Keynesian economics is a school of macroeconomic thought that was developed in the post-war period from the writings of John Maynard Keynes. A group of economists , attempted to interpret and formalize Keynes' writings, and to synthesize it with the neo-classical models of economics...