30 Jul 2018

What Is the Quality of the Fiscal Policy in Poland?

Mainstream economic theory indicates that the optimal fiscal policy must fulfill at least two basic conditions: it must be sustainable and counter-cyclical. According to the commonly used definition formulated by Evsey Domar in 1944, the first condition is met if the public debt to Gross Domestic Product (GDP) ratio converges toward a constant value in the long run. In other words, the government is bound by an intertemporal budget constraint, so it cannot finance its spending by increasing the debt-to-GDP ratio indefinitely. Countercyclical policy, in turn, is one that reduces the amplitude of the business cycle fluctuations, meaning it is expansionary during economic slowdowns and contractionary during economic expansions. According to the “Tax Smoothing Paradigm” formulated by Robert Barro in 1979, optimal fiscal policy should also smooth out the level of tax rates over time. All these elements combined constitute the mainstream economic consensus according to which public debt-to-GDP ratio should oscillate around a constant value (increasing in times of economic slowdown and decreasing in times of economic prosperity).

The practice of political and economic life shows, however, that actual fiscal policies deviate from this model – notoriously so. Beginning in the 1970s, the debt-to-GDP ratio has been growing in many countries, particularly strongly in developed economies, where it reached levels heretofore unknown in times of peace. According to the IMF data, in 2017 it reached 86.6% in the euro area, 112.9% in the G20 advanced countries, and 118.6% in the G7 countries. Those numbers indicate unambiguously that in the last half-century fiscal policy in the abovementioned countries has been conducted in an unsustainable manner. Among them is a number of EU Member States that have been recently teetering on the verge of bankruptcy and had to turn for assistance to institutions such as the International Monetary Fund, the European Financial Stability Fund, and the European Stability Mechanism.


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