The economies which appealed to the IMF loan faced difficulties related to financing the public and the private foreign debt. IMF imposed the promoting of a restrictive fiscal policy to the beneficiary countries, in order to decrease the budget deficit, e: fiscal policy stance, structural budget balance, IMF agreement, economic recession

Marinas Marius-Corneliu

English

Research Papers in Economics

412 
 
WHY IS THE FISCAL POLICY IMPOSED BY IMF PRO-CYCLIC? 
 
Marinaş Marius-Corneliu 
Academy of Economic Studies, Department of Economics, Bucharest marinasmarius@yahoo.fr 
Telephone: 0721/32.62.97 
 
The economies which appealed to the IMF loan faced difficulties related to financing the public and the 
private foreign debt. IMF imposed the promoting of a restrictive fiscal policy to the beneficiary countries, 
in order to decrease the budget deficit, even though they have already been in an economic recession and 
they would need to promote a new expansionary fiscal policy, which allows implementing the measures 
mentioned  in  the  national  anti-crisis  plans.  As  a  result,  imposing  new  pro-cyclic  fiscal  policies  will 
emphasize the recession within these economies, and this will contribute to decreasing the individuals’ 
available incomes and, as a consequence, to the occurrence of social discontents (as in Latvia, Hungary, 
Ukraine and Serbia). 
Keywords: fiscal policy stance, structural budget balance, IMF agreement, economic recession 
JEL Classification: E32; H30; H50. 
 
Fiscal policy stance 
In order to catch the restrictive/expansionary character of a fiscal policy, the structural budget 
balance has to be calculated. This variable represents the current budget balance, out of which the 
cyclic component of the budget was eliminated (meaning, the cyclically adjusted current budget 
balance). The calculation of this variable is necessary because the budget balance reflects the 
influence of both some cyclic (transitory) factors, and of some structural (permanent) ones. The 
transitory component refers to the variations generated by the GDP’s cyclic evolutions, and the 
structural  component  takes  into  consideration  the  modification  of  the  budget  balance,  if  the 
economy would produce at the level of the potential GDP. The cyclic part of the budget is 
determined depending on the budget balance’s sensitivity to the economic cycle, because the 
returns from taxes are influenced by the evolution of the national revenue (within the Euro zone, 
approximately 90% of the budget revenues come from taxes). With regard to the public expenses, 
only those referring to the unemployment assistance are sensitive to the evolution of the GDP, 
and their share is only of 5%. The result is that the cyclic variation of the budget balance is 
mostly explained by the modifications of the budget returns. 
The output gap is calculated as the difference between the current GDP (Ya) and the potential 
GDP (Yp) :   Y Y Y Y Y Y P a p a ∆ + = ⇒ − = ∆ .  
The current output is composed of the potential one to which a cyclic component is added. 
According to this relation, the decomposition of the current budget balance can be obtained as it 
follows: 
SBA = SBS + SBC, where: 
SBA – the current budget balance; SBS – the structural budget balance (at the level of Yp) 
SBC – the cyclic budget balance (which corresponds to the output gap). 
SBA is obtained as the difference between the budget returns (from taxes T) and the budget 
expenses (including transfers), as it follows: SBA = T – (G+TR). The function of the taxes takes 
into consideration both the taxes which are independent of the revenue level (the autonomous 
taxes – n), and those directly influenced by its evolution ( Y t⋅ , where t represents the marginal 
rate of taxation). 
) ( n TR G Y t SBA a − + − ⋅ = ;  ) ( n TR G Y t SBS p − + − ⋅ =  
If a restrictive fiscal policy is promoted (for example, the increase of taxation or the decrease of 
transfers),  then  the  structural  budget  balance  will  get  increased  ( SBS  >  0).  If  it  records  a 
decrease, then the promoted fiscal policy becomes expansionary. It is considered pro-cyclic if it 
is restrictive under the terms of a recessionary output gap and expansionary in the case of an 413 
 
inflationary output gap. An anti-cyclic fiscal policy is that which aims to stopping the recession 
or to impede the economic expansion. 
 
Why Did IMF Intervene? 
IMF  Managing  Director  Dominique  Strauss-Kahn  considers  that  the  solution  to  the  global 
problems consists in promoting an expansionary fiscal policy and not a restrictive one, but not 
each economy can promote such expansionary measures. The economies facing difficulties in 
financing the budget deficit/the public debt service must promote a restrictive fiscal policy, even 
though it passes through a recession period. 
 
IMF's main criterion to give the financial help is the situation of the public finances, but it also 
gives loans for financing the short-term payable debt (both public and private). According to 
IMF's logic, not only the state has to promote austerity, but also the private economic agents 
(companies, consumers). Under the terms of going through the economic recession, the states 
beneficiary of the IMF loan will record a decrease in the budget returns and they will have to 
decrease their budget deficit either by limiting the public expenses, or by increasing taxation, the 
both measures generating an emphasis of the economy's decline. These have been the evolutions 
in the European countries which benefited by the IMF loan – Latvia, Hungary, Serbia, Ukraine 
and Romania. The next sections I make analyses by comparing the macro-economical situations 
in Latvia and Hungary with Romania's macro-economical evolution. 
 
Hungary's vulnerabilities. The constraints imposed by IMF 
Hungary's current problems represent the consequence of the populist measures promoted in 
2002, namely giving a supplementary pension to the retirees (the 13
th pension), the increase with 
50% of the wages for all the public employees and giving some advantages (exemptions from 
taxation) to the political clients. From a macro-economical point of view, in 2008 Hungary has 
been  characterized  by  non-fulfilling  any  criterion  of  nominal  convergence,  while  Romania 
fulfilled only the public debt criterion. The comparison with Romania (table 1) emphasizes the 
relatively faster adjustment of inflation and of the current account deficit.  
 
Table 1. Comparison between Romania's and Hungary's macro-economical evolutions 
Resemblances with Romania  Differences from Romania 
Budget deficit over 3% in 2008 – minus for Romania  The public debt increased from 52% in 2001 to 67% 
in  2008,  thus  reflecting  average  annual  budget 
deficits  over  7%  between  2002-2007;  -  plus  for 
Romania 
The  average  inflation  rate  was  over  6%  in  2008 
(6.1% in the case of Hungary) 
Hungary is going through a recession period ( the 
3rd  and  the  4th  quarters  recorded  an  economic 
decline) - plus for Romania 
The  vulnerability  in  the  banking  sector  at  the 
Hungarian  forint’s  depreciation  (more  than  half  of 
the banking credits given to the private sector are in 
a foreign currency) 
In  January,  the  inflation  rate  decreased  to  3.1%  - 
minus for Romania (6.7%) 
The approximately 15% depreciation of the national 
currency  at  present,  compared  to  the  beginning  of 
2008. 
The foreign debt is approximately 100% of the GDP 
– plus for Romania 
The  average  inflation  rate  was  over  6%  in  2008 
(6.1% in the case of Hungary) 
The current account deficit was 6.1% of the GDP in 
2008 – minus for Romania (approx. 12.5%) 
  Foreign  currency  reserves  of  approx.  16  billions 
Euro – plus for Romania 
 414 
 
Hungary obtained almost 20 billions Euro (26.5 billions dollars) not to go into payment default, 
but the receiving of the installments is conditioned by promoting some restrictive and pro-cyclic 
fiscal policy measures, such as: 
- decreasing the public expenses in order to improve the long-term fiscal sustainability; 
- reduction the share of the public sector in economy (in 2008 it was 49%, a level which is  
  superior to the EU-15 average of 46%); 
- wage freezing in the budgetary sector in 2009; 
- limiting the 13
th pension to a level of 260 Euro (80,000 HUF) and eliminating it for those retired  
- with anticipation. 
Latvia's vulnerabilities. The constraints imposed by IMF 
In 2008, Latvia was characterized by a unique cocktail of three factors of risk: 
  -  the  economy's  overheating  based  on  a  crediting  advance  of  approximately  70% 
  of the GDP  
  - during the last 5 years; 
  -  the  monetary  council,  because  of  which  the  promoted  monetary  policy  could  not 
  by anti-cyclic; 
  -  a  very  high  share  of  the  short-term  foreign  debt  (over  50%),  the  highest  among 
  the new EU  
  - member countries. 
Latvia recorded a hard landing of economy, after which, during the 2003-2007 period, it recorded 
an economic growth average rate of 8% and an increase of the private crediting in the GDP with 
approximately 70 percents. Latvia fulfilled three of the nominal convergence criteria – the budget 
deficit, the public debt and the stability of the rate of exchange (under the terms of a fixed rate of 
exchange).  The  comparison  with  Romania  emphasizes  a  relatively  less  favorable  macro-
economical situation, the resemblances mainly referring to the share in the GDP of the public 
debt and at the rate of unemployment level (table 2).  
Table 2. Comparison between Romania's and Latvia's macro-economical evolutions 
Resemblances with Romania  Differences from Romania 
The decreasing of the demand was reflected in the 
current deficit’s adjustment beginning with the 3rd 
quarter  of  2008,  approx.  12.5%,  a  level  which  is 
similar to that in Romania 
The  current  account  deficit  recorded  values  over 
12%,  starting  with  2004,  reaching  a  maximum  of 
27% of the GDP during the 4th quarter of 2006 – 
plus for Romania (the deficit did not exceed 14% of 
the GDP) 
A low share of the public debt in the GDP, near to 
13%  in  2008  (12.3%  for  Latvia  and  13.5%  for 
Romania) 
The 25% decrease of the foreign currency reserves 
between  October-December  2008,  in  order  to 
maintain the rate of exchange to a fixed parity with 
Euro – plus for Romania  
The  biggest  banks  in  Latvia  ensured  the 
Government that they would continue to guarantee 
the  financing  necessary  for  the  economy’s 
functioning (resemblance with Isărescu’s statement). 
Latvia is already going through a recession period, 
recording a 10% GDP decrease at the end of the 4th 
quarter of 2008 - plus for Romania  
Almost a third of the employed population works in 
the public sector.  
The  confidence  in  the  banking  sector  is  low 
(withdrawals of deposits occurred): the Latvian state 
nationalized the country’s second bank  (Parex) – 
plus for Romania 
The wages in the public sector were raised over the 
economic  growth  rate,  and  those  from  the  private 
sector  rose  over  the  growth  rate  of  labour 
productivity. 
The foreign debt is 130% of the GDP at the end of 
2008 – plus for Romania 
The rate of unemployment was approximately 6.7-
7%, according to the Eurostat methodology in 2008. 
The inflation rate reached a maximum of 17.7% in 
May 2008 and it decreased to 11.8% in November – 
plus for  Romania 415 
 
 
Latvia obtained a loan from IMF of 7.5 billions EUR, approximately 45% of the GDP recorded in 
2008. The fiscal objectives fixed by IMF for Latvia refer to: 
  -  decreasing  the  wages  in  the  public  sector  with  15%,  as  well  as  the  decreasing  of 
  the budgetary  
  - personnel, eliminating the bonuses/incentives given to the public employees; 
  - decreasing the subsidies, except the social security benefits; 
  - introducing a 10% tax on dividends, interests, rent, starting with 2010; 
  - the three percents increase from 21% of the normal VAT rate and the increase  from  5% 
to 10% of  
  - the decreased VAT rate which has a much more restraint basis of taxation   (mainly 
the medicines); 
  -  the  increase  of  the  fuel  excise  (achieving  the  communitarian  acquis),  as  well  as  a 
  partial compensation by decreasing the rate of taxation of the natural persons'   revenues 
with 2 percents; 
  -  freezing  the  pensions  and  their  indexation  on  the  inflation  rate  only  starting  with 
  2010. 
Receiving the future installments is conditioned, first of all, by the compliance with the target of 
the budget deficit; even though the level settled for 2009 is 5%, the Government considered that 
the unfavorable evolution of the economy generates the deficit's automatic increase to a level 
which is superior to the value of 10%. As a consequence, the compliance with the established 
budgetary threshold will involve the emphasizing of the fiscal policy's and economic recession's 
restrictiveness. 
 
The provisions in the IMF's agreement with Romania 
The main objective of the loan consists of diminishing the effects of the strong decrease in the 
private capital entries and of properly financing the disequilibrium in the Romanian economy. 
The intermediary objectives refer to the medium-term promotion of a fiscal strengthening policy 
(by decreasing the public expenses) and of a restrictive monetary policy (in order to comply with 
the NBR's inflation target). The budget deficit which must be complied with by Romania in 2009 
is inferior to that in 2008, under the terms in which the economy will record an approximate 11% 
decline  compared  to  the  previous  year,  and  the  budgetary  returns  will  get  decreased,  this 
automatically leading to the increase of the budget deficit. As a consequence, Romania has to 
promote a restrictive and pro-cyclic fiscal policy, the main measures for decreasing the budgetary 
expenses aiming to: 
-  significantly decreasing the expenses with the wages in the public sector, by decreasing the   
   bonuses and the other benefits; 
- eliminating 137.000  vacant jobs; 
- continuously decreasing the subsidies intended for the public entities; 
- eliminating the increases in wages for the public sector (a total of 5%) planned for 2009 or the  
  corresponding decreasing of the personnel number; 
- unifying the wage grid in the budgetary sector, so that the bonuses could peg at 25% of the total  
  expenses with the personnel; 
- indexation of the public pensions at the prices index and not at the evolution of the revenues  
  from the average gross wage in economy; also, there will occurs the raise of the retiring age   
  (especially for women) according to the average expectation of life. 
 
Conclusions 
The agreement with the IMF does not automatically generate a decrease of the macro-economical 
risks for an economy, under the terms in which a restrictive fiscal policy is promoted. Thus: 416 
 
- the national currency is not appreciating (the national currencies from Hungary, Ukraine, Serbia 
recorded depreciations even though these countries have signed agreements with the IMF); 
- the country rating is not getting improved as a consequence of the agreements  with  the  IMF 
(Ukraine’s and Latvia’s ratings were low); 
- the domestic economic agents’ confidence in the economy’s evolution is not   getting 
improved.  According  to  the  Economic  Sentiment  Index  (ESI),  calculated  by  the  European 
Commission, ESI decreased in Latvia from 77 in November 2008   to 53.4 in February 2009, 
and ESI in Hungary decreased from 75 in October 2008 to 39 in February 2009. 
-  an  agreement  with  the  IMF  is  not  increasing  the  stability  of  the  banking  system;    on  the 
contrary, the recession is getting deeper and the incapacity to repay the  credits  is  getting 
increased through the promoted restrictive policy. 
 
References: 
1. Buti, M.; Van den Noord, P.(2004) „Fiscal policy in EMU. Rules, discretion and political 
incentives”, European Economy, nr. 206 
2. Comisia Europeană, (2007) „Cyclical adjustment of budget balances”, DG ECFIN Economic 
Forecasts 
3. Comisia Europeană, (2005) „New and updated budgetary sensitivities for the EU budgetary 
surveillance”, DG ECFIN 
4. Hein, E., Truger, A.(2006) „Fiscal policy and macroeconomic performance in the euro area – 
lessons for the future”, IMK Working paper, nr. 7 
5.  International Monetary  Fund  (2008) „Hungary:  Request  for  Stand-By  Arrangement,”  IMF 
Staff Report, No. 08/361, November 17 
6. International Monetary Fund (2009) „Republic of Latvia: Request for Stand-By Arrangement,” 
IMF Staff Report, No. 09/3, January 9 
7.  Muchhala,  Bhumika.  (2009)  „The  IMF's  Financial  Crisis  Loans:  No  change  in 
conditionalities.” Penang, Malaysia: Third World Network. Accessed online on April 20 
8. OECD (2007) „Economic survey of the euro area”, Policy brief 
9. Taylor, J.(2000) „Reassessing Discretionary Fiscal Policy”, Journal of Economic Perspectives, 
American Economic Association, vol. 14(3) 
10. Weisbrot, Mark. (2007) „Ten Years After: The Lasting Impact of the Asian Financial 11. 
Crisis,” in Ten Years After: Revisiting the Asian Financial Crisis. Washington D.C: Woodrow 
Wilson Center for International Scholars. 

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Economic survey of the euro area”,

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New and updated budgetary sensitivities for the EU budgetary surveillance”,

Reassessing Discretionary Fiscal Policy”,

Republic of Latvia: Request for Stand-By Arrangement,”

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The IMF's Financial Crisis Loans: No change in conditionalities.” Penang, Malaysia: Third World Network. Accessed online on

Truger, A.(2006) „Fiscal policy and macroeconomic performance in the euro area – lessons for the future”, IMK Working paper,

WHY IS THE FISCAL POLICY IMPOSED BY IMF PRO-CYCLIC?

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WHY IS THE FISCAL POLICY IMPOSED BY IMF PRO-CYCLIC?

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