The following OECD assessment and recommendations summarise Chapter 3 of the Economic Survey of Iceland 2006 published on 9 August 2006.
Fiscal policy should be more supportive of monetary action
From a longer-term perspective, the government’s fiscal position is sound in international comparison; the public debt-to-GDP ratio is low and pressure arising from ageing-relating public expenditure is seen to be moderate due in part to the country’s occupational pension system having become fully funded. The government’s medium-term fiscal programme rightly aims at maintaining fiscal balance, with a substantial surplus having been achieved in the current upswing. However, while monetary tightening aimed at curbing inflation pressures continues, the fiscal stance, as measured by the change in the cyclically-adjusted primary balance, is estimated to be loosening inappropriately in 2006. The main reason for this is substantial tax cuts decided in 2003 for structural reasons. With macroeconomic imbalances considerably wider than expected when the 2006 budget was adopted, a tightening of fiscal policy is required. The expansionary effect of tax cuts needs to be offset by additional spending restraint so long as there is no clear evidence that the economy is cooling down. This could be achieved, for example, through wage moderation and delaying public investment. Indeed, the government recently announced further postponement of large public projects (of both the central government and large municipalities) going forward. The authorities should maintain a tighter fiscal stance in the 2007 budget through below trend real expenditure growth. It is important that local governments also take part in these stabilisation efforts.
Public expenditure control needs to be reinforced
Spending overruns remain an issue. Government expenditure has not only continued to overshoot nominal budgeted levels but has also exceeded the medium-term growth ceilings for public consumption and transfers in real terms. This slippage both undermines the role of fiscal policy in demand management and limits the scope for tax reductions that are in principle desirable for supply side reasons. To enhance spending discipline, the process of budget planning and execution needs to be tightened. This requires stricter enforcement of existing regulations and generalised use of output-based budgeting. So far, medium-term projections of budget items in nominal terms have been purely indicative and the deviation from initial projections for areas such as education has been large. To further strengthen the medium-term orientation of expenditure policy and control, the introduction of multi-year budget plans should be considered, with spending limits set to rigorously limit real spending growth, but then made binding in nominal terms. Expenditure pressures have been particularly strong at the municipal level. Hence, binding annual agreements between the central and local governments should ensure the achievement of national spending objectives.
Per cent of GDP
Source: OECD, Economic Outlook 79 database.
The Policy Brief (pdf format) can be downloaded. It contains the OECD assesment and recommendations but not all of the charts included on the above pages.
The complete edition of the Economic Survey of Iceland 2006 is available from:
For further information please contact the Iceland Desk at the OECD Economics Department at email@example.com. The OECD Secretariat's report was prepared by Hannes Suppanz and Peter Tulip under the supervision of Patrick Lenain.