Tight fiscal policy can as well be expansionary under certain circumstances. This was the case with Turkey after the 2001 crisis. In some other cases, however, the exact opposite applies.

The fiscal policy could have been tighter in 2011, a year when even official statements complained about the high current account deficit. When general government budget balance is adjusted for positive or negative revenue and expenditure impacts stemming from economic cycles, the “structural budget balance” is derived. This enables you to identify whether and to what extent fiscal policy was tightened or loosened year-on-year. Such analysis reveals that structural budget balance of Turkey has deteriorated slightly in 2011 compared to 2010. The second problem about the fiscal policy relates to the quality of fiscal discipline. In some cases, prices of publicly-controlled goods and services were kept constant for a long period and then increased substantially. In some other cases, additional budget revenue was generated by raising taxes on such goods and services. Such practices, however, pose the risk of disturbing the relative price structure and impeding the Central Bank’s efforts to control inflation. With the narrow tax base, that is, with the large size of taxpayers who do not or insufficiently fulfill the duty of paying taxes, such practices can become indispensible. And this is what I meant with the problems about the quality of fiscal discipline. 

Fiscal policy is highly successful

Despite the mentioned negative aspects, Turkish fiscal policy is highly successful. The biggest indicator is the low public debt – GDP ratio. With the bailout operation initiated after the 2001 crisis mainly for public banks, the ratio of central government debt stock to GDP jumped to 77 percent. As of the end of 2011, the ratio stands at 40 percent. Over the same period, public sector net debt stock calculated taking into account certain assets and liabilities of the Central Bank in line with the EU methodology decreased from 71 to 22.4 percent. Recently, it was announced that some part of the revenues generated via the 2B lands would be used to lower the public debt stock, which, if realized, will be a successful step.

A critical debate has been going on in developed countries, particularly in the US and Europe, lately. With the US recovery weaker than expected and the economic contraction across Europe except Germany and a couple of small economies, arguments that early fiscal tightening would be harmful started to be voiced frequently. On the other hand, another group of countries, Germany among them, argues that fiscal tightening can ease the concerns caused or to be caused by high public debt stock and thus reduce the confidence in the economy, in turn stimulating private consumption. This way, they claim, negative impact on growth of fiscal tightening can be offset with the rise in private consumption. 

Expansionary or contractionary?

Such debates essentially refer to the preference between expansionary fiscal policy and contractionary fiscal policy. This brings us back to a principle which regular readers of this commentary are familiar with. There is no “taking sides” in science. Yes, tight fiscal policy can as well be expansionary under certain circumstances (when the economy suffers from high public debt and therefore high risk premium and real interest rate, for example). This was the case with Turkey after the 2001 crisis. In some other cases, however, the exact opposite applies. If public debt stock is not high (as was the case in Turkey during the 2008 crisis) or if the public debt stock is high but your borrowing tool is still attractive and thus you enjoy low borrowing interest rates (as in the US) there will be no danger in loosening the fiscal policy at some degree. Such policy contributes positively to short-term growth.

This commentary was published in Radikal daily on 01.05.2012