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Jean-Marc Fournier, Takuma Hisanaga, and Anh D. M. Nguyen

. Governments need to react to rising debt . Governments should generate surpluses to restore buffers when public debt is high, while this is not needed when debt is low. Highly indebted governments should react less to adverse shocks . The debt buffer has an insurance value—it is the “reserve” of debt that the government can issue to smooth shocks. When the buffer is small, the probability of market stress is high and the marginal value of an extra unit of buffer is large. This provides an incentive to preserve buffers to guard against future shocks. As a result, when debt

International Monetary Fund. Asia and Pacific Dept

stabilizer. The stabilizing role of fiscal policy is constrained by adverse effects of higher debt—a rise in risk premium—and an implementation lag. Based on this set-up, the model recommends an optimal fiscal stance reflecting the following principles (See Appendix for details of the model.): Governments should smooth the cycle . Counter-cyclical fiscal policy dampens recessions and avoids distortions during overheating, thus improving short-term utility. Highly indebted governments should react less to adverse shocks . The debt buffer has an insurance value—it is

International Monetary Fund. European Dept.
This Selected Issues paper analyzes Belgium’s fiscal stance using a structural stochastic model. This note uses a theoretical model that explicitly accounts for the trade-offs between the short-term cost of fiscal tightening and the long-term gains associated with higher fiscal buffers. This paper shows that once the current crisis is over, rebuilding fiscal buffers is essential to helping Belgium confront the next shock from a stronger fiscal position. Overall, this illustrates a major motivation for a credible medium-term fiscal consolidation strategy. When a government reduces debt, it increases its capacity to react to shocks later. This entails a short-term cost that is, in the case of Belgium, worth the effort as this capacity to smooth future shocks increases future welfare. In addition, a large capacity to react with fiscal policy reduces the risk of long-lasting effects of a large crisis. Historical data show that in the past, the Belgium government’s reaction to the cycle was limited to a single event. By contrast, if Belgium could firmly anchor public debt on a downward path, future governments would be able to offset downturns while keeping debt sustainability concerns under control.
Jean-Marc Fournier, Takuma Hisanaga, and Anh D. M. Nguyen
This paper assesses Japan’s fiscal stance in the past and the future with a stochastic structural model called the Buffer-Stock Model of the Government. Our retrospective analysis suggests that the fiscal stance in the 1990s and the early 2000s was overall looser than the model recommendations. As for the future, the model advises the near-term fiscal policy to be supportive with a view to narrowing the output gap and minimizing hysteresis, while recommending a fiscal consolidation over the medium-term at a gradual pace.
International Monetary Fund. European Dept.

reinforces the motive to counter negative shocks. The model provides a recommendation that is consistent with a given assessment of future growth and interest rate prospects, the output gap and the capacity of the government to offset shocks (fiscal multiplier). As assessments are surrounded by uncertainties, policy makers also need to exert judgments on these assumptions. To guide the judgment, the model can describe the extent to which recommendations are sensitive to the main assumptions. 4. Highly indebted governments should react less to shocks . The debt buffer

International Monetary Fund. Western Hemisphere Dept.

buffers, and, finally, we offer tools to assess debt buffers . In particular, we use the IMF fiscal rule database to illustrate the international experience with fiscal rules in general, and debt rules in particular, and we use IMF 2018a to define a debt ceiling, a debt anchor, and a cash buffer for Chile. B. Conceptual Framework and International Experience with Fiscal Rules and Anchors 6. A key objective of fiscal rules is to ensure the sustainability of fiscal policy . By putting a cap on deficits, expenditure, or debt, fiscal rules help building buffers to