Who decides whether fiscal policy is credible and on what basis do they decide? In our experience, governments usually seek the approval of their fiscal policies from four key groups.


First, governments seek the approval of financial markets because their approval will be critical in determining the cost of borrowing for the government, as well as for other borrowers in the economy.


Currently financial markets are not concerned about Canadian fiscal policy at least at the federal level. Bond yields are extremely low and Canada has a triple-A rating. Part of the reason for this is the very high level of credibility that the Canada earned with the elimination of the deficit in the 1990s, followed by a long period of surpluses and declining debt. The Conservative government has been able to take advantage of this legacy despite the emergence of a deficit in 2009, because of its commitment to a sustainable medium term fiscal framework.


At the same time, Canada’s fiscal situation continues to be the best in the G-7. Canada also experienced a mild recession in 2009-2010 compared to other countries and Canada’s financial sector performed very well compared to financial institutions in other G-7 countries. These developments have helped maintain Canada’s fiscal credibility reputation internationally. Most importantly financial markets are simply more focused on the debt crisis in Europe.


Second, Governments seek the approval of important stakeholder groups, representing business, labor, consumers and educational institutions to mention only a few. This is done through extensive pre-and post-budget consultations. They are important because it is these sectors that will make the decisions that will affect investment, output, and employment. 


They also represent the “talking heads” that the media will consult for their opinions and.  They can significantly affect public opinion by their reaction to government policies.


Third, Governments also seek the approval of the media, both domestic and international, because the media is critical in shaping public opinion.  If initial media reaction is negative, then it could be difficult to change their observations and conclusions.


Fourth, but definitively not last, Governments must seek the approval of the general public.  They must carefully explain why action is necessary, the nature of the actions being considered, and how such actions affect them.


 The public must be convinced that actions are necessary, that they are equitable and that they will lead to long-term benefits, even though there may be short-term pain.  In some cases, the public may be ahead of the government in demanding credible fiscal actions to control the buildup of debt.


What do these groups consider in deciding if fiscal policy is “disciplined” or “credible”?


First, fiscal policy must be realistic. By that we mean fiscal policy should be based on sound analysis and a careful and balanced view of economic and fiscal prospects, challenges and risks. Fiscal policy should not be based on a “rosy” or unrealistic view of future economic and fiscal prospects.


Second, fiscal policy must be responsible. This means the government must be committed to establishing and maintaining a sustainable medium-term fiscal framework, one that supports long-run economic growth through control of public debt. A sustainable fiscal framework is one in which the debt-to-GDP ratio is either stable or declining.


Such a framework should be able accommodate temporary fiscal actions taken to stimulate aggregate demand and cushion fluctuations in output, provided these actions do not lead to permanent structural imbalances and a rising public sector debt burden in the medium term.


Third, fiscal policy must be prudent by including a reasonable amount of “insurance” to guard against forecast error, and the impact of unforeseen events and policy actions. 


Finally, fiscal policy must be transparent. This means providing full disclosure of analysis and information, since without this, governments cannot be held accountable.  Such analysis should not be restricted to the current planning period, but identify potential risks in the future.


What should we look for in judging the credibility of the 2012 budget?


Will the 2012 Budget take a “realistic” view of economic and fiscal prospects?


The government does not have a good record when it comes to realistic economic assumptions. The Minister of Finance, in his November 2008 Economic and Fiscal Update, produced a fiscal forecast showing surpluses as far as the eye could see.  When it comes to adopting an “unrealistic” view of economic and fiscal prospects, this has to be one of the most unrealistic forecasts ever made by a Canadian government.


For the 2012 budget, the government is faced with a very difficult economic outlook, both internationally and domestically. The EU is in recession and the only question is how deep and how long it will be. The EURO Area (EA) is going through major adjustments and the very existence of the EA in its current form is in serious doubt. Whatever the outcome, it will take decades or longer for the adjustments to resolve themselves.


There are signs of some recovery in the U.S. economy but the consensus is that the U.S. economy is likely to undergo a decade of lost growth and high unemployment. It will take years for the U.S. to resolve its deficit and debt problems.


Canada is also facing serious economic challenges, in the short term, the medium term, and the longer term. Households are overburdened with debt, businesses are not investing, despite record profits, because of the global and domestic uncertainties, and all levels of governments are curtailing their spending and thereby acting as a drag on growth. The private sector has failed to step in to support the recovery as the stimulus has been removed.


Coupled with a slowing export market, it is not surprising that forecasts of Canadian growth have been reduced by international institutions, such as the OECD and the IMF, and even by the economic forecasters that the Department of Finance consults. There is nothing but significant downside risks on the horizon.


How the budget reflects these international and domestic developments and uncertainties will be key in determining its credibility.


Will the budget take “responsible” policy  actions to ensure a sustainable fiscal framework?


Sustainability means that the government is prepared to take the policy actions needed to ensure that the debt burden of the government is stable and, even better, declining.


This should be easy because the government already has a sustainable fiscal framework. Based on the government’s own numbers the debt-to-GDP ratio will decline over the period to 2015-16. With the unilateral announcement that the growth of the Canadian Health Transfer will be held to the growth of GDP, the PBO has concluded that the debt ratio will continue to decline to the year 2020.


Contributing to this sustainable fiscal framework are the $4 billion in annual expenditure cuts that the government has been attempting to identify for the past 10 months. After months of conditioning the public that major cuts (possibly $8 billion a year) could be expected, the government is now saying they will be “moderate” and that most job losses will be the result of attrition. The government appears confused on why to cut, how much to cut, and when to cut.


In fact the Minister of Finance has now said that the budget will not include details of the cuts. This would mean that Parliament would be asked to approve a budget without details on the expenditure cuts. The details will be included in Part III of the Main Estimates, which would not be tabled in Parliament until May. This would leave only one month for Parliament to review and approve Departmental spending.


This confusion, lack of information and transparency will seriously undermine the credibility of the budget and the Minister of Finance.


The Minister of Finance has said that the real focus of the budget will now be on growth and job creation.  And he is right. The budget needs to set out a clear strategy to strengthen the underlying growth potential of the economy. It is an accepted fact that potential economic growth is slowing as the population ages and employment growth declines. Productivity growth continues to slow.


The government needs to address the key question of how to promote savings and investment, innovation and technological advancement. This will be the real test of the government’s budget credibility.


Will the government adopt a prudent approach to budget planning?


We would describe a fiscal plan as prudent if the plan includes adequate “insurance” against unforeseen events and inevitable forecasting error. The purpose of the “insurance” is to protect the fiscal targets as much as possible and to give confidence to financial markets and stakeholders that the targets will be achieved. This enhances the credibility of the fiscal plan.


In the mid-1990s, prudence was important to enhance the credibility of the annual fiscal targets.  With the emergence of balance budgets and increasing surpluses, the need for prudence became less evident.  However, prudence was still required to ensure that the current year point-estimate deficit target would be met without having to take in-year action, which could be extremely disruptive to departmental planning.


The government has recognized the risks in economic forecasting and a small economic prudence factor was included in the 2009 budget. This was removed in the 2010 budget, but was re-introduced in the 2011 budget. The adjustment for risk amounted to a downward adjustment of only $1.5 billion in fiscal revenues in each year of the forecast.   In the November 2011 Update, this adjustment for risk was increased to $3.0 billion for 2011-12, $4.5 billion for 2012-13, $3.0 billion for 2013-14 but only $1.5 billion for each year thereafter.


An allowance for risk in the economic outlook of $1.5 billion is only about one-quarter of the allowance made by the previous government during a period when the economy was much smaller. The 2005 budget, for example, included prudence increasing to $7 billion in the fifth year of the forecast, equivalent to 4 per cent of total government revenues.


Given the significant uncertainties both globally and domestically a prudent approach to budget planning would require a substantial increase in the prudence adjustment that the budget, one that rises over time rather than falls.


This would increase the credibility of the budget. The tradeoff is that it would mean delaying the target year for deficit elimination.


Will the government adopt a transparent approach to budget planning?


At the present time, budget planning lacks transparency. This has not always been the case. This is unfortunate given that the government was elected on a commitment to improve both transparency and accountability.


Conservative and Liberal governments in the 1980s and 1990s provided numerous policy discussion papers for public discussion and debate. The Mulroney government in 1984 and the Chretien government in 1994 published detailed outlines of the economic growth agendas that they intended to pursue. It was common for budgets to include detailed policy analysis.


Regrettably the government has chosen not to follow this approach to policy making. This surprising since the creation of the PBO was the result of a commitment made by the Conservative government during the 2006 election to promote greater “transparency and accountability” in budget planning. This has not been the case. Since its creation, PBO has been in a constant battle with the government over its independence, inadequate budget, and lack of staff. In addition the government has denied the PBO access to data that it needs to do its work. 


The latest example of this is the claim by the government the Old Age Security (OAS) retirement program was not “sustainable”. The PBO issued a report that concluded that, allowing for the decision by the government to hold the growth of the CHT to growth of nominal GDP, OAS is in fact “sustainable. In other words even without changing the age of eligibility for OAS the government’s debt burden would decline.


You would think that the Minister of Finance would be happy with conclusion since it supports the government’s claim the they are good fiscal managers. Instead the Minister of Finance accused PBO of being “unbelievable, unreliable, and incredible” even though he was unwilling or unable to provide the government’s own analysis and projections. PBO has asked that the government make its projections public.


The transparency record of the government could be improved if it released two documents in the budget or at least detailed analysis. First, given the focus that the government is now putting on an ageing population, the government should release a paper that reviews all the consequences of an ageing population (not just sustainability) and the policy changes that may need to be considered.  This should be done not only for the federal government but for the total government sector.


A second, given that the priority of the 2012 budget, and hopefully future budgets, will be strengthening economic growth and job creation, the government should provide a detailed blueprint on how it plans to proceed in the coming years.


Transparency and accountability are key to good policy making and fiscal credibility.

























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