New HKS Working Paper: Looking to Chile for Fiscal Sanity

February 28, 2011
by Doug Gavel

The United States and the rest of the world have a lot to learn about public sector finance from government policies in Chile. That is the argument presented in a new Harvard Kennedy School Working Paper authored by Professor Jeffrey Frankel.

“A Lesson from the South for Fiscal Policy in the US and Other Advanced Countries” provides an extensive analysis of Chilean fiscal policies over the past ten years.

“Fiscal policy in the United States, United Kingdom and other advanced countries became less countercyclical after 2001, as governments wasted the opportunity of the 2002-07 expansion period by running large budget deficits,” Frankel writes. “Meanwhile fiscal policy in Chile became more countercyclical – saving in the boom and easing in the 2008-09 recession – during the same decade that rich countries forgot how to do it. It has achieved countercyclical fiscal policy by means of some institutions that could usefully be adopted by other countries.”

Frankel argues that Chile has been able to achieve fiscal stability by establishing structural budget targets (that is, targets for the cyclically adjusted budget) and a less politicized mechanism for judging what is structural and what is cyclical.

“Chile’s key innovation was to vest responsibility for estimating the long-run trends in budget determinants in panels of independent experts. Other countries might usefully follow Chile’s lead, and develop independent institutions that would determine whether a given year’s deficit is structural or temporary. The alternative is that politicians, inclined to wishful thinking, forecast that booms will continue indefinitely, with the result that revenue is spent rather than saved,” Frankel concludes.

Jeffrey A. Frankel is James W. Harpel professor of capital formation and growth at Harvard Kennedy School. He directs the Program in International Finance and Macroeconomics at the National Bureau of Economic Research, where he is also on the Business Cycle Dating Committee, which officially declares recessions. Nominated by President Clinton in 1996 to be a Member of his Council of Economic Advisers, Frankel's responsibilities included international economics, macroeconomics, and the environment.

Photograph of Professor Jeffrey Frankel

Jeffrey Frankel, James W. Harpel professor of capital formation and growth

“Chile’s key innovation was to vest responsibility for estimating the long-run trends in budget determinants in panels of independent experts. Other countries might usefully follow Chile’s lead, and develop independent institutions that would determine whether a given year’s deficit is structural or temporary."

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