April 14, 2015/IMF Blog

By Vitor Gaspar

Does fiscal policy respond systematically to economic activity? Can fiscal policy promote macroeconomic stability? Does greater stability support stronger growth? The answer is yes on all counts. This finding, while seemingly obvious, is now backed by numbers to match each question. The April 2015 Fiscal Monitor explores how.

A novel approach

To measure whether fiscal policy contributes to stability, the Fiscal Monitor introduces the novel concept of the fiscal stabilization coefficient (FISCO). FISCO measures how much a country’s overall budget balance changes in response to a change in economic slack (as measured by the output gap).

If FISCO is equal to 1 it means that when output falls below potential by 1% of GDP, the overall balance worsens by the same percentage of GDP.

The higher the FISCO, the more counter-cyclical is the conduct of fiscal policy, where governments build fiscal buffers in good times that they can then rely on during bad times. The average FISCO among advanced economies is 0.7, with considerable cross-country differences (see chart 1). For the FISCO for individual countries (including advanced, emerging market and developing countries) see Xavier Debrun’s blog “Growth Dividend from Stabilizing Fiscal Policies”.

The FISCO takes into account the fact that many revenue and expenditure items respond to the state of the economy even though the underlying provisions or programs were primarily designed for other reasons. Monitoring the relationship between the budget balance and the output gap would help policymakers understand how much their action contributes to output stability, including in comparison to other countries.