How Credible is Fiscal and Financial Policy?

Commentators often devote much attention to whether a budgetary and monetary policy is "sustainable" and therefore credible. But there often seems to be no common framework within which such assessments can be made. In Discussion Paper no. 13, CEPR Programme Director Willem Buiter attempts to develop a forward- looking, comprehensive accounting framework for the public sector. He constructs what he calls the the "present value budget constraint" (PVBC) of the public sector. What is this constraint? Nothing more than an analogue of the kind of constraint that economists impose on consumers and firms when analysing their behaviour over time. This constraint stipulates that current and future spending, discounted over time, must equal current and future revenues discounted in the same manner. Buiter suggests that government fiscal and financial policy be judged analogously, by considering whether the sum of current and discounted future spending plans is equal to the sum of current and discounted future revenues (net of any outstanding liabilities). When these two sums are equal, Buiter calls the fiscal and financial plan "consistent".

What items should the public sector balance sheet contain? In addition to the familiar financial assets and liabilities, Buiter suggests the following items: the public sector capital stock, valued in terms of the future revenues - if any - it is expected to yield; the value of public sector property rights in land and natural resources; the present value of expected future seigniorage from government money creation; the present value of future taxes net of transfers and subsidies; and the present value of future planned public sector capital formation, privatization or nationalization programmes. He argues that future public sector investment and nationalization (on market terms) should only increase the measure of public sector net worth to the extent that the public sector uses the resources involved more efficiently than the private sector. Conversely, privatization (on market terms) should only augment public sector net worth to the extent that the private sector manages the resources more efficiently than the public sector.

Suppose that a fiscal and financial plan is "inconsistent" in the sense that discounted spending exceeds discounted revenues. Then from the "stock" PVBC Buiter suggests a number of different "flow" deficit concepts. Each one emphasizes a different aspect of the "sustainability" of current and prospective fiscal, financial and monetary plans. Together they provide a framework for organizing facts and plans about fiscal, financial and monetary policy and for evaluating the consistency of spending and revenue projections or scenarios, public sector debt objectives and monetary targets. One flow deficit concept which Buiter discusses is the "permanent deficit", which is the annuitized value of the difference between the discounted spending and revenue plans. It represents the "permanent" adjustment to expenditures or revenues which is required to make the plan "consistent". Buiter provides some strictly illustrative, back-of-the-envelope calculations of this measure for the UK, 1978-1982. His calculations show a gradual move from "permanent deficit" to a "permanent surplus"in these years. In 1983 and in the current year, the relaxation of fiscal policy has probably largely eliminated these surpluses.

Measuring Aspects of Fiscal and Financial Policy
W H Buiter

Discussion Paper no. 13, April 1984 (IM)