When should a country run a Fiscal Surplus

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Fiscal adjustment policies should be designed within an overall methodological framework that links the implementation of a set of policy measures to the achievement of the economy's objectives for inflation, growth, and external balance. Rebalancing growth towards domestic demand has emerged as a key post crisis for sustaining developing a country's  rapid growth in the medium and the long term. What matters most for rebalancing are specific fiscal measures tailored to each country's unique circumstances. The primary contribution of fiscal policy is to help remove the structural impediments and distortions that stand in the way of (i) a better balance between external and domestic demand and (ii) a better balance being production for both domestic and foreign markets. In this context, the composition of public spending matters in the rebalancing process. 

Specific areas of government expenditure are health, education pensions and social protection. The shifting of public expenditure towards those areas will boost household disposable income and encourage them to spend more and save less. On the supply side, removal of taxes and subsidies that favor export production over domestic production will promote a more balanced output structure, as will the removal of fiscal distortions favoring manufacturing over services. There is thus a wide range of fiscal measures that government can implement tostimulate domestic consumption, as well as production geared toward domestic consumption, by altering the incentives of firms and households.       

 The micro economic effects of fiscal policy depend on the size of crowding out effects. An increase in government provision of services will not result in a one-to-one increase in total provision of services, but it may significantly reduce private consumption on expenditure on such services.      

There are certain circumstances when the appropriate balance for a country is likely to be a surplus -

1. TO FINANCE PRODUCTIVE EXPENDITURE : When Governments provide "lumpy" goods such as large investment projects, it makes sense to finance them through borrowing rather than by raising tax rates. This borrowing can then be repaid from a fiscal surplus when public spending is low. If the private sector has the capacity, but not the funds, to provide certain productive goods, Govt. can step in by lending on-line funds it has borrowed, which, when repaid, may lead to a surplus; the Govt. may also choose to run a surplus in order to increase savings available to the private sector through the capital market.  

2. TO STABILIZE THE ECONOMY: To reduce inflation and/or the current account deficit, fiscal contraction is usually necessary and may imply a surplus. To dampen business cycles, Govt. can smooth aggregate demand  over the cycle, which may imply a surplus during a boom. A negative supply shock (such as drought), a positive demand shock (such as property boom) or large capital inflows also justify a fiscal contraction, which may imply a surplus. 

3. TO BUILD UP WEALTH: When certain proceeds, such as mineral income, foreign grants or privatization receipts, are exceptionally high, Govt. should save a portion for future use. To the extent, these receipts are classified as as revenue, this may imply a surplus. Similarly, with an aging population, a pension scheme should run a surplus, which if consolidated, into the budget, may imply a fiscal surplus. 

4. TO SUSTAIN THE DEBT: If Government debt is unsustainable, a primary fiscal surplus will be necessary, and the debt problem may be so severe as to require an overall surplus. Of course, a surplus itself may increase the sustainability of Govt. policies by sending a highly visible signal to economic agents of the Govt.'s prudence.  

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