Converging to a comprehensive risk-adjusted fiscal sustainability analysis
1. Discussion of
Converging to a Comprehensive Risk-Adjusted
Fiscal Sustainability Analysis
by George Kopits
EUROPEAN FISCAL BOARD (EFB)
ADEMU Conference on Fiscal Risk
University of Bonn
July 6-7, 2017
Some issues for discussion
• Assessing risks versus hedging against risks
• Exogenous shocks versus endogenous risks (taking into
account important second, and higher, round effects)
• More information – transparency - accountability
• Volatility and growth
3. Assessing risk versus hedging against risk
“ … the right answer to crisis avoidance is controlling risk.
The appropriate conceptual framework is Value-at-Risk – a
model-driven estimate of the maximum risk for a particular
balance sheet situation over a specified [time] horizon.
There are genuine issues of modelling, but there is no issue
whatsoever in recognizing that this approach is the right
one. If authorities everywhere enforced a culture of risk-
oriented evaluation of balance sheets, extreme situations
such as those [during the financial crisis] in Asia in 1997
would disappear or, at the least, become a rare species. ”
Rudiger Dornbusch (1998, 2002)
"How do you hedge against the assassination of Archduke
Douglas Rediker (FT 2017) former IMF executive director for the
"Uncertainty must be taken in a sense radically distinct from
the familiar notion of Risk, from which it has never been
properly separated.... The essential fact is that 'risk' means in
some cases a quantity susceptible of measurement, while at
other times it is something distinctly not of this character."
Frank Knight (1921)
Risk versus uncertaintyAssessing risk versus hedging against risk
• Forecasting is always a matter of grappling with
• But then, do we have all the information we need
in order to set accurate odds in the first place?
• Extrapolation from past experience sound only if
we can assume that observations are generated by
a stationary process.
• And even if we assessed risks correctly, can or do
we want to do anything about it? Policy response?
Assessing risk versus hedging against risk
6. Exogenous shocks versus endogenous risk
Focusing on exogenous shocks is not enough. Exogenous
shocks trigger an amplifying spiral, via declines in asset
prices and reductions in credit expansion which give rise
to major second, and higher, round effects.
New methods of risk assessment (e.g. systemic CCA)
•put greater emphasis on interconnectedness;
•capture linkages between institutions and the extent to
which they precipitate or amplify general market
•can be used to simulate the mitigating or amplifying
effects of alternative macro-prudential arrangements.
Exogenous shocks versus endogenous risk
• How are spill-overs from the financial sector to the
public sector modelled?
• Interconnectedness is already difficult to model for
financial sector: what are implications for
government sector? How to value implicit
guarantees? More than implicit guarantees?
• Are there differences in spill-over risks from and to
government sector in euro area countries versus
parts of complete monetary unions?
More information only necessary
condition for better policies
Budgetary risks of ageing well known
since at least mid-1980s; some EU
member states still ill prepared.
Accountability improves with more
information only in case of fiscal
Better information does not solve
political economy problem
Countries that have experienced financial crises have, on
average, grown faster than countries with stable financial
conditions. Rancière, Tornell, Westermann (2008) Systemic
Crises and Growth, Q J Econ, 123 (1): 359-406.
[…] the “bright” and “dark” sides of financial innovation. We
find supportive evidence for both the innovation-growth and
the innovation-fragility views. Beck, Chen, Lin, Song(2016)
Financial innovation: The bright and the dark sides, J of
Are crises the price to pay for higher growth?
Volatility and Growth
10. Converging to a comprehensive risk assessment