Monday, January 25, 2010

Weekly Hurriyet Column: Ruled by an Unruly Fiscal Rule

Below is the unedited version of my column for this week. You can read the final version at the Daily News website. Let's start with the cheesy references, as there are plenty this week: As you already know, I use the phrases "friendly neighborhood economist" and "spider senses", and obviously they are one of my favorite superheros- Clark Kent is another, as he is a journalist:). I owe "we are not amused" to Queen Victoria. And last but definitely not the least, "it's not you, it's me" is used often, but I had in mind in Seinfeld's George Constanza, who claims to have invented it:)

Coming to more serious matters, there is a recent IMF paper that more or less tells everything you need to know about fiscal rules. The impression I got from reading the paper is that the Fund is leaning a bit towards marketing fiscal rules as the new "fad policy tool", just as inflation targeting was in the last two decades. But the paper does acknowledge that a fiscal rule is neither a necessary nor a sufficient condition for a strong fiscal hand. I think a good comparison could be made with inflation targeting, as I had written at the end of September. Like inflation targeting, it is the institutional set-up, credibility and reputation that come along with the fiscal rule that actually do the magic. BTW, one of the reasons there isn't much research on fiscal rules was the lack of a comprehensive database on fiscal rules. The same IMF paper also introduces a new comprehensive Fund database on fiscal rules, so we should be seeing some interesting empirical work on soon.

Coming back to Turkey, the losses emanating from messing up the fiscal rule would be much greater than messing up with inflation targeting, especially since we are in a year of rough fiscal waters, as I have argued many times in my columns. That's what I was intending to say at the end of my column... So, here we go:

Economics Minister Ali Babacan held one of his occasional dinner discussion sessions with about a dozen columnists last Wednesday, to which your friendly neighborhood economist was again not invited.

I am not sure whether the fault lies with the Daily News or me, but my spider sense is whispering the “it isn’t you, it is me”. If that is the case, I would be tempted to say that we are not amused, but the perennial optimist in me is hoping that being an avid reader of columns, the Minister did not need me present to know what I am thinking. Then, it is my civic duty to share my views on the discussion topics, based on the columns of my more esteemed colleagues present in the dinner.

I have to say that I do not share the Minister’s optimism on the economic outlook. Although he is jubilant on the recent higher-than-expected revenues, I prefer to remain worried on the non-interest expenditures, which are on the way to spiraling out of control. As for his overoptimistic growth projections for the last quarter of 2009 and this year, the latest economic indicators unfortunately do not vindicate his views.

Coming to the IMF agreement, it is relaxing to see that Babacan and I are on the same page regarding the need and benefits for a Stand-by, so the only question is whether he will be able to convince his boss. Surprisingly, almost all the columnists were against an agreement, so I am hoping they did not manage to talk him out of it.

The most interesting part of the discussion, and in fact the only new hat, was more details on the fiscal rule, which first surfaced in the Medium-term Economic Program in September. As outlined there, rather than targeting government debt directly, the rule will spit out the planned change in the budget deficit based on a debt sustainability formula. Now, it seems that the inclination is towards adopting a target deficit to GDP ratio of 1 percent and growth rate of 5 percent, which are conservative enough even for my tastes.

But I am not sure a numerical policy rule makes sense for a country with a poor fiscal track record like Turkey if it is not accompanied by procedural rules such as a cap on non-interest expenditures. Moreover, I will not be convinced of its implementation unless the rule is hammered into the constitution and ensured with an independent and authoritative budget monitor or fiscal council. Using the existing institutional set-up, as suggested by Babacan, makes it only more likely to fail.

Then, there should be clear costs of breaking the rule, even though I have full confidence in the stick of the markets. Last but definitely not the least, the government would also have to address concerns over lack of full transparency and shenanigans in public accounts.

Interestingly enough, all this talk brought sweet memories. Stopping at Harvard’s Kennedy School of Government during his inaugural road show back in 2003, the Minister had evoked a well-known debt sustainability formula, only for the Venezuelan economist Ricardo Hausmann to note in return that Turkey would need to grow more than the 15 percent real interest rate to bring down debt levels.

Both the Turkish economy and Babacan have come a long way since then. If anything, with the interest rates of 2003, even suggesting a fiscal rule would have been deemed outright crazy. In fact, being at a point where a fiscal rule is debated as a viable possibility is a success story in itself.

But what if the government makes the fiscal story linger on for much longer like the IMF saga? Or falls into an institutional set-up trap? Or messes up the implementation?

Then, the risk is that they will regret having mentioned those two words in the first place.

No comments: