Fiscal Sustainability: Conceptual, Institutional, and Policy Issues

Abstract

Since 2008, the world economy has been facing the consequences of the global financial crisis. One consequence has been the rapid growth of public debt in many advanced economies, resulting from overly optimistic estimates of the fiscal situation before the crisis, declining government revenues and increasing social expenditures during the crisis, costs associated with the restructuring of the banking system, and countercyclical fiscal policies, among others. Emerging market economies appeared more resilient immediately after the 2008-2009 crisis; however, declining commodity prices and decelerating growth during 2014-2016 have weakened their fiscal positions.

Faced with a growing debt burden, many governments have attempted to determine the “safe” level of fiscal deficit and public debt. However, this is not an easy task. There is no single standard of fiscal safety for all economies. Furthermore, a globalized economy and irregular business cycles make it difficult to determine in which phase of the cycle a given economy is at any moment. This is essential to the assessment of fiscal indicators.

Experience shows that default risk may occur at various, and sometimes seemingly very low, levels of public debt. In fact, a “safe” borrowing level is country specific and depends on many factors and often-unpredictable circumstances. However, given the tense situation in global markets, the “safe” level of public debt is now lower than in previous decades. Another argument in favor of a cautious approach to setting this level concerns the highly pro-cyclical nature of measures such as the fiscal deficit-to-GDP or public debt-to-GDP ratios.

Lessons from the latest crises also highlight the importance of more accurate estimations of countries’ contingent fiscal liabilities, namely those relating to the stability of the financial sector. Looking ahead, estimations of other contingent liabilities, particularly those related to social welfare systems (the implicit debts of the public pension and health systems) are of primary importance in the context of an aging society and a population decline. In most countries, these liabilities far exceed official public debt figures. That is, official debt statistics do not present an adequate picture of a nation's public debt and the true fiscal burden that will be passed on to the next generations of taxpayers.

Keywords: public debt, fiscal deficit, fiscal policy, public finance management, general government, fiscal rules

JEL Classification: E62, H62, H63, H81