Should Barbados follow other countries and adopt special fiscal rules?
Budget outcomes in the Caribbean have been generally poor and show a deficit bias. Caribbean history is littered with serial drastic and painful fiscal adjustments that are often followed by fiscal indiscipline, which then necessitate another round of socially and politically uncomfortable adjustments.
The problem is compounded by the fact that these recurring fiscal adjustments often burden the politically weak and economically vulnerable citizens more than those who are well off, given that the poor normally do not gain much during the post adjustment period.
Given the view about the inadequacy of the political process in several Caribbean nations to effectively put in place consistent countercyclical fiscal policy, as well as the poor track record, policy discussions have revolved around whether it is time to adopt numerical fiscal rules, and less frequently, the option of creating fiscal councils.
A fiscal rule is a long term constant imposed on fiscal policy through legislated numerical limits on fiscal aggregates. The central aim of fiscal rules is to provide a credible medium term fiscal anchor by making the policy framework apolitical.
This allows for correcting distorted incentives and containing political pressures to overspend, especially in good times, with a view to ensuring fiscal discipline over time.
To be effective, fiscal rules need to be legislated in a way that makes it difficult for them to be changed. In more extreme cases, this means constitutional changes but at the very least they need to be enacted and monitored in a way that binds the hands of the policymakers under potential political sway.
An alternative to legislated fiscal rules is the creation of a fiscal council – an independent publicly funded entity staffed by non-elected professionals mandated to provide non-partisan oversight of fiscal performance and/or advice and guidance from either a positive or normative perspective on key aspects of fiscal policy.
Various functions include public assessments of fiscal plans, and an evaluation or provision of macroeconomic and budgetary forecasts.
Their advice, although not binding – hence not tying the hands of politicians – aims at achieving fiscal prudence through fostering transparency, promoting a culture of stability, and raising the reputational and electoral costs of undesirable policies and/or broken commitments.
Macroeconomic fiscal outcomes have been poor in the Caribbean, and the region remains open to external vulnerabilities. Fiscal policy is neither countercyclical nor does it avoid deficit bias. As a result, it does not prevent debt from reaching unsustainable levels time and time again.
Clearly, the existing rules-procedures-institutational framework is unable to achieve desirable fiscal outcomes. Perhaps, it is time to bind the hands of government, both the executive as well as the legislature. The problem is that they will have to tie their own hands for the good of their citizens, but any hasty implementation will only be met with more fiscal failure.
A slow and deliberate – but no too slow – movement toward a rules-based regime that allows the Caribbean countries to satisfy the preconditions, followed by a transition to the new regime, would effectively guard against fiscal myopia and political cycles as well as enhance the credibility of medium-term fiscal targets. However, in some cases it may make sense to be opportunistic in implementing a rules-based regime as opposed to trying a slow and deliberate transition if the underlying political economic conditions so permit.
• These views are based on a new paper authored by Inter-American Development Bank economists Sarosh R. Khan and Inder Jit Ruprah.
