Fiscal Stabilization Funds: A Means to What End? Peter DeVries Department of Finance Canada June 2002

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1 Fiscal Stabilization Funds: A Means to What End? Peter DeVries Department of Finance Canada June

2 Overview / Framework (1) Reasons for adopting stabilization funds (2) International examples and experience (3) Canadian examples and experience Fiscal stabilization funds have been around for a long time. However, they been the subject of renewed interest as countries consider how to adapt fiscal policy for times of surplus, and how to ensure long-term sustainability in the face of population ageing. The purpose of this presentation is to highlight some key issues involving stabilization funds and to provide a very brief overview of some of the international experiences with a focus on Canada. As well, I will try to examine the effectiveness of stabilization funds on fiscal performance. First I will begin with an overview of the reasons for adopting stabilization funds. Then for each reason or motivation, I will try to provide some background discussion and review some international examples and experience. Fortunately, in Canada, we cover all the bases and therefore I will be able to complement the international examples with some Canadian examples. 2

3 Reasons for Stabilization Funds Non-renewable resource revenues Achievement of fiscal targets Saving to address longer-term needs There are three main reasons for establishing a fiscal stabilization fund. First, the presence of a large supply of non-renewable resources can be of great benefit to a country; however, the uncertainty surrounding the revenues generated by exhaustible resources can pose significant fiscal challenges. Second, several countries have adopted some form of fiscal target, such as a balanced budget rule or debt repayment. Some jurisdictions have established a fiscal stabilization fund to help them achieve their fiscal objectives. Third, most countries face pressures resulting from an ageing population. Stabilization funds can be used as a vehicle to save surplus funds now to address spending pressures in the future. Let s look first at non-renewable resource funds. 3

4 Non-renewable resource revenues Key problems: Revenue stream is uncertain and volatile Supply is exhaustible In this context, a stabilization fund can be thought of as a share of Non-renewable resource revenue put aside when such prices are high to offset the impact when such prices decline. This decline in revenue could arise from a fall in the natural resource price or depletion of the resource itself. Now typically, a national or sub-national government that derives a large share of its revenues from a non-renewable natural resource faces two main problems. First problem -- a revenue stream that is uncertain and volatile. Obviously, a volatile and uncertain revenue stream is problematic for several reasons, and I will touch on these shortly. But in this case, a stabilization fund (or a non-renewable natural resource fund) could help to reduce fluctuations in budgetary revenues essentially by taking in excess revenues when the resource price is high or paying funds to the budget when the price is low. Second problem an exhaustible supply. The exhaustibility of a revenue stream also raises issues. Here a fund could help to save some of the revenue generated from this finite natural resource, providing income after the resource is exhausted. Of course, how much revenue from this resource should be saved is a key question. 4

5 Non-renewable resource revenues Challenges for fiscal and economic policy Instability in revenues complicates budget planning Difficulty in distinguishing between temporary & permanent shocks Depletion of wealth Dutch disease So what challenges are posed for fiscal and economic policy? First, instability in revenues due to the volatility and uncertainty of natural resource revenue complicates budget planning. When revenues change sharply and unexpectedly, current and/or capital expenditure might have to be cut, which could be socially damaging and/or could affect the productivity of public investment. Of course it is possible to dissave and accumulate debt to smooth the adjustment in expenditure if the shock to the revenue stream is temporary. On the other hand, if the shock is permanent, then expenditure would have to be adjusted accordingly but at least dissaving could help soften the transition. Unfortunately, it is rarely the case in that one is able to distinguish between temporary and permanent shocks. As a matter of prudence, one might want to treat negative shocks as permanent and positive shocks as temporary until more information and analysis reveals a shock s true nature. Next, the depletion of wealth raises issues related to intergenerational equity and fiscal sustainability. For example, if all the revenue from this resource were consumed, there would be less wealth and lower consumption for future generations. In terms of sustainability, fiscal indicators might show short-term strength but mask longer-term weaknesses due to wealth depletion. And finally, there is the Dutch disease where large resource revenues tend to it th l h t d i th t d bl t 5

6 How effective are non-renewable resource funds (NRFs)? Empirical evidence: expenditures in some countries with NRFs tend to have a more limited response to changes in resource prices than countries without NRFs Data also suggest that these countries followed prudent expenditure policies before and after establishing an NRF How effective have Non-Rrenewable Revenue Fund (NRF) or stabilization funds been? In evaluating the effectiveness of NRFs, analyst have attempted to assess the effect of an NRF on government spending. One would expect that an NRF would be effective if expenditure responded less to changes in resource prices in a country with an NRF as opposed to a country without one. As well, one might expect that an NRF would also be effective if its establishment resulted in a downward shift in the path of expenditure which would be the case for a savings fund. A recent IMF study (Occasional Paper #205 by J. Davis et al. (2001)) found that expenditures in some countries with NRFs have tended to respond less to changes in resource prices compared to those countries without NRFs, suggesting some degree of effectiveness. (However the study notes that we should be a bit careful since this result was not uniform.) However, the research also suggests that these countries followed prudent expenditure policies before and after establishing and NRF. Thus, it could be argued that establishing the fund helped countries maintain prudent policies in the face of ongoing revenue volatility. 6

7 How effective are non-renewable resource funds (NRFs)? Country experience: NRFs associated with a variety of operating rules and fiscal policy experience In several cases, rules bypassed/changed and do not themselves seem to have constrained spending Integration of NRF operations with overall fiscal policy has often proven problematic As well, one could also proceed on a case-study basis and review countries experiences with NRFs to evaluate their effectiveness. And here one would want to determine if and how the NRF constrained government behaviour. In summarising countries experiences, the IMF study notes that NRFs are associated with a wide variety of operating rules and fiscal policy experiences. The study finds that in several cases, the NRFs rules were frequently by-passed or changed, effectively incorporating an element of discretion. The NRFs themselves do not appear to have effectively constrained spending. The IMF country survey also finds that the integration of the NRF into the overall fiscal policy framework has often proved problematic. The study provides a good example of this in its discussion of Venezuela s fund. 7

8 International examples of NRFs Norway s State Petroleum Fund Chile s Copper Stabilization Fund Venezuela s Macroeconomic Stabilization Fund Let s look briefing at some international examples and experience. Several countries at this conference have had vast experience with such funds and representatives here would be much more knowledgeable about these funds. Norway: fund est. in 1990 but activated in 1995 following achievement of budget surpluses. Net oil revenues transferred to the fund and the fund finances the budget non-oil deficit. Thus the fund is effectively a government account. As well, there are no specific rules for accumulation or withdrawal. The fund helped provide a long-term framework for the annual process setting the non-oil budget. But, Norway has typically followed sound fiscal and macroeconomic policies before and after fund. Chile: fund est. in 1985 following sustained increase in international copper price. Accumulation and withdrawal rules based on reference copper price determined by authorities. Fund may have helped government s resist spending pressures in late 1980s and mid 90s. Like Norway, fiscal and macro policy have generally been sound. Venezuela: fund est. in 1998 with objectives of insulating the budget and economy from fluctuations in oil prices. Contributions to fund specified as oil revenues above a reference value. Rules governing accumulation and withdrawals modified based on fixed reference price of oil. More changes currently being discussed. Integration of fund with central government s operations have been problematic. The central government was in deficit in 1999 and 2000 despite recovery in oil prices but still had to make contributions to the fund, which it did in part by borrowing 8

9 Non-renewable resource fund: Alberta The Alberta Heritage Savings Trust Fund was created in 1976 Primary objective: save a proportion of extraordinary non-renewable resource revenue for future generations Now I will turn to an example closer to home and one that I am more familiar with. In Canada, the province of Alberta has extensive non-renewable energy resources. In 1976, the province established the Alberta Heritage Savings Trust Fund with the primary objective of saving a portion of the royalties from non-renewable resources for future generations. So essentially this fund falls into the savings fund subcategory of NRFs. 9

10 Non-renewable resource fund: Alberta Each year, a portion of non-renewable resource revenue was deposited into the Fund until Until , 95, withdrawals from the Endowment Fund supported various capital initiatives Since , 97, only investment income in excess of the amount needed to inflation-proof the Endowment is transferred to the General Revenue Fund Each year up to and including , the government deposited a portion of nonrenewable resource revenue into the Fund. Between and , the Fund was used to support various capital projects in the province. After , only interest income was withdrawn from the Fund, and beginning in , only the interest income in excess of the amount needed to inflation-proof the endowment is transferred to the government s general revenues. For , the balance of the Heritage Savings Trust Fund is estimated at $12.2 billion and investment income transferred from the Fund to the General Revenue Fund is forecast at $573 million. Background: Alberta s fiscal legislation requires balanced budgets on an annual basis, without exception. This Fund is not used to stabilize the fiscal position from year to year, since the endowment remains intact and only interest income is transferred to general revenues. The province has established other smaller endowments that support research in the 10

11 Reasons for Stabilization Funds Non-renewable resource revenues Achievement of fiscal targets Saving to address longer-term needs Now, let s turn to discuss the second reason or motivation for stabilization funds -- the achievement of fiscal targets. 11

12 Achievement of fiscal targets Fiscal Stabilization Funds can aid in the achievement of fiscal targets. However, fiscal rules are often designed to attain the same results. Several countries have implemented fiscal rules in order to attain fiscal targets. Furthermore, some provinces in Canada have established Fiscal Stabilization Funds to complement their fiscal rules. Fiscal Stabilization Funds can aid in the attainment of fiscal targets, such as balanced budget rules; although this is not the only means by which to achieve certain fiscal objectives. For instance, many countries have enacted fiscal rules in order to attain the same results. In fact, some Canadian provinces have created Fiscal Stabilization Funds to help achieve their fiscal targets. These funds are mainly used to smooth the fiscal position from year to year. 12

13 Fiscal rules to achieve fiscal targets Reasons for adopting fiscal rules: Ensure macroeconomic stability Enhance credibility of fiscal policy and help in deficit elimination Ensure long-term sustainability of fiscal policy Minimize negative externalities within a federation or international arrangement In practice, fiscal rules have been adopted for a variety of reasons, for example: To ensure macroeconomic stability, as in post-war Japan; To enhance credibility of fiscal policy and help in deficit elimination, as in many Canadian provinces; To ensure long-term sustainability of fiscal policy, especially in light of population ageing, as in New Zealand; or To minimize negative externalities within a federation or international arrangement, as in the European Economic and Monetary Union. Underlying most rules is a sense that present or future governments, for any number of reasons, may not be willing or able to implement optimal fiscal policy measures without external pressure, or legislatively imposed constraints. 13

14 Fiscal rules to achieve of fiscal targets However, the adoption of fiscal rules raises a number of concerns: rules may limit government s ability to engage in countercyclical fiscal policy rule must impose constraint yet still be flexible fiscal rules alone cannot guarantee fiscal discipline; political commitment is necessary. At the same time, the adoption of fiscal rules raises a number of concerns: The main concern is that fiscal rules may be overly restrictive and limit a government s ability to undertake countercyclical fiscal policy when necessary. Second, the way in which the legislation is drafted is also important a balance must be struck so that the rule imposes a clear constraint yet at the same time allows some flexibility, to ensure that it is not simply discarded or circumvented through creative accounting or other nontransparent measures. Finally, it is important to note that fiscal rules alone cannot guarantee fiscal discipline; political commitment to the spirit of the rules is also required to ensure that rules are not circumvented. 14

15 Types of fiscal rules in practice Budgetary Balance Controls Debt Restrictions Tax or Expenditure Controls Referendum for New Taxes United States Maastricht Treaty Germany Japan, New Zealand Sweden Federal Canada, 1991/92-95/96 American States Canadian Provinces The fiscal rules that are currently in effect can be grouped into four main categories: The most common type of fiscal rule is a restriction on the budgetary balance. This may take the form of 1. balanced budget requirements, as in many American states and Canadian provinces; 2. the Golden rule, which specifies that deficits may only be run to fund investment, as required in Germany; 3. or specific target levels, such as the 3-per-cent deficit reference level under the Maastricht Treaty. The second most common fiscal rule consists of debt targets or restrictions. For example, the Maastricht Treaty sets a reference value for gross government debt at 60 per cent of GDP. Also, most American states impose restrictions on government issuance of general obligation debt. Most limits are based on a formula involving state revenues or appropriations, while some impose maximum dollar limits. A few states prohibit the issuance of general obligation debt. A third type of fiscal rule involves limits on tax or expenditure, as seen at the federal level in the US and Sweden, in several US states and in Canada from FY1991 to FY1995. Fourth, some US states and Canadian provinces require approval by referendum for new taxation initiatives 15

16 Types of fiscal rules in practice Budgetary Balance Controls Debt Restrictions Tax or Expenditure Controls Referendum for New Taxes Nova Scotia New Brunswick Quebec Ontario Manitoba Saskatchewan Alberta British Columbia Yukon Most Canadian provinces have enacted some form of budgetary balance rule that may apply to each fiscal year or over a 4-year cycle. Manitoba and Alberta have legislated debt repayment plans for their general purpose debt and unfunded pension liabilities. The Yukon Territory permits deficit balances, but prohibits the accumulation of a net debt position. Nova Scotia s legislation attempts to limit spending increases by requiring that new programs be financed from existing budgets. While Alberta s legislation has no limit over spending increases in the budget, only 25% of unbudgeted surpluses can be allocated to spending increases or tax cuts. The remaining 75% of the unexpected surplus must be applied to debt repayment. Four jurisdictions require a referendum vote to increase or create new taxes. 16

17 Effectiveness of fiscal rules in achieving fiscal targets No comprehensive, international empirical studies on importance of fiscal rules in determining fiscal performance: most empirical studies focus on US states. Most of these studies suggest that fiscal rules can affect fiscal outcomes. Varying results as to whether rules constrain governments ability to use countercyclical fiscal policy. In terms of assessing the effectiveness of fiscal rules in achieving fiscal targets, there are no comprehensive empirical studies involving a wide sample of countries. However, there have been a number of empirical studies at the sub-national level in the United States, as well as a few studies of other countries, which offer insight into the usefulness of fiscal rules. Most studies of the US states indicate that fiscal rules can impact on fiscal outcomes, although results have been mixed as to whether fiscal rules impede a government s ability to engage in countercyclical fiscal policy. Research done in my Department (Kennedy and Robbins 2001) concludes that fiscal rules can be useful tools in achieving fiscal targets; however, a comparison of countries with and without legislated fiscal rules shows that they are not necessary for success. 17

18 Funds to achieve fiscal targets: New Brunswick Established in with a deposit of $100 million Primary Objective: to stabilize the fiscal position from year to year and improve long-term fiscal planning After an additional deposit of $70 million into the Fund in , 02, the province budgets a withdrawal of $80 million in to maintain a small surplus position Now I would like to discuss some examples of stabilisation funds in Canada. The province of New Brunswick established a Fiscal Stabilization Fund in with the purpose of stabilizing the fiscal position from year to year and improve longterm planning. After an additional deposit in , the province plans to withdraw $80 million in in order to maintain a small surplus position. This Fund complements the province s fiscal rule of a balanced budget over a fouryear periods beginning with to As a result of an accounting revision that changed a surplus position into a deficit position for , the first four-year period ( to ) target balance was missed. 18

19 Funds to achieve fiscal targets: Quebec Created in with an endowment of $950 million Primary Objective: to fund capital projects or projects with a defined duration or of public interest Later amended to allow the reserve funds to be used to maintain a balanced budget under certain conditions The province withdrew the entire reserve in in order to maintain a balanced budget ($650 million) and support new spending initiatives ($280 million) Quebec s Budget announced the creation of the Budgetary Surplus Reserve Fund as a result of a larger-than-expected surplus in The budgetary reserve was initially created with the purpose of modernizing the health, social services and education networks and for implementing new social solidarity and research initiatives. Eligible capital projects were to be non-recurring, with a defined duration and complementary to existing government programs. However, the Budget announced that the reserve legislation would be amended to allow the funds to be used to maintain a balanced budget under certain circumstances: 1) a disaster, 2) a significant deterioration of economic conditions or 3) a change in federal transfer programs that reduces transfer payments. According to its balanced budget legislation, Quebec must attain a balanced budget on an annual basis. The accumulated amount by which the province bettered its previous legislated targets may be used to offset a deficit (approx. $1.9 billion available for ). 19

20 Funds to achieve fiscal targets: Manitoba Established in with a deposit of $200 million Primary Objective: stabilize fiscal position from year to year and improve long-term planning Target balance of the Fund is 5% of operating expenditures Expected withdrawal of $93 million in in order to meet legislated debt repayment requirements For , 03, the Fund balance is expected to be $285 million, or 4.1 per cent of operating expenditures Manitoba was the first of the Canadian provinces to establish a Fiscal Stabilization Fund. The stated objective is to stabilize the fiscal position from year to year and to improve long-term planning. The legislation specifies a target balance for the Fund of 5% of operating expenditure; however, the attainment of this target is not enforced. Even after the planned withdrawal in , the balance of the fund is expected to be 4.1% of operating expenditures. Background: Manitoba has relatively comprehensive fiscal legislation, requiring an annual balanced budget. Under the legislation, the budgetary balance is defined as revenues minus expenditures, before extraordinary events and transfers from the Debt Retirement Fund to the Operating Fund (for debt repayment) and after transfers to the Debt Retirement Fund and from the Fiscal Stabilization Fund. 20

21 Funds to achieve fiscal targets: Saskatchewan Created in with an endowment of $775 million Primary Objective: to assist in the fulfilment of long- term objectives by stabilizing the fiscal position from year to year Target balance of the Fund is 5% of revenues $411 million planned withdrawal in in order to achieve a balanced budget 2002 Budget outlines plan to withdraw the remaining balance of the Fund by Saskatchewan created its stabilization fund in with an objective similar to that of New Brunswick and Manitoba. Each year, the Minister of Finance is required to present a four-year plan, whereby at the end of the fourth year, the balance of the Fiscal Stabilization Fund is expected to be 5 per cent of total revenues of the General Revenue Fund for the third year of the four-year plan. However, given that the province plans to withdraw the balance of the Fund by the end of , the province is in the process of amending its legislation to eliminate the target balance for the Fund. Background: Saskatchewan has enacted a fiscal rule that legislates a balanced budget over a four-year cycle. Exceptions to the balanced budget rule are made for major, unidentifiable events that have an adverse impact on expenditures or revenues. Furthermore, the legislation prohibits the use of the net proceeds from the sale of a Crown corporation assets to increase operating expenditures. 21

22 Federal approach to fiscal targets in Canada 1991 to 1995: Legislated limits on program spending. Objective: Control level of program spending. While the federal government in Canada has not created a stabilization fund, it introduced a variety of fiscal rules to help achieve its fiscal targets. The first involved spending controls From to , the federal government had legislated limits on federal program spending. The legislation indicated that over this five-year period, spending subject to control could not exceed the amount set out in the 1991 Budget. (Optional: Reason for legislation) Over the five-year period, spending was lower than set out in legislation. This was due in part to a reclassification of some spending to tax expenditures and cuts in spending announced in the 1995 budget to address the deteriorating fiscal situation. The legislation had a sunset clause and was not extended past

23 Federal approach to fiscal targets in Canada 1994: Two-year rolling deficit targets based on prudent planning assumptions Objective: Provide credible, achieveable short-term term fiscal deficit targets, ultimately balancing the budget. In addition, the government began setting two-year rolling deficit targets, based on prudent economic planning assumptions. The economic assumptions are based on the average of private sector economic forecasts, not the Government s own economic assumptions. These private sector assumptions are also adjusted to include an extra amount of economic prudence. To purpose of this approach was to set targets for which the government would be held accountable, with an ultimate goal of a balanced budget. The short-term focus implied that the government would have to take action immediately if it appeared the targets would not be met. It also meant that the government could not implement long-term commitments that would have rising costs over time. 23

24 Federal approach to fiscal targets in Canada 1995: Incorporate a Contingency reserve into the budget planning, which, if not needed, is applied to deficit/debt reduction. Objective: Protect against unforeseen adverse changes in the economy or forecasting errors. To further ensure that the targets would be met, the government also included a Contingency Reserve in its budget plan. This Reserve was to be used only to offset the impact of adverse economic developments on the achievement of the fiscal targets. It is not a source of funds for new policy initiatives. If not needed, it is applied to deficit or debt reduction. 24

25 Effectiveness of the federal approach Federal spending levels were effectively lower than legislated limits in nearly every applicable year. Successful fiscal consolidation with surpluses in every year since Nearly $36 billion in debt repayment between and Firm political commitment to continue to meet targets, without the need for a Fiscal Stabilization Fund. As a result of prudent economic planning assumptions and credible, short-term fiscal targets, along with a firm commitment from the government to meet these targets, the federal government was able to move from a deficit to a surplus position in without the need for a stabilization fund. It has reported a surplus each year since. And despite the global economic slowdown in 2001, the federal government is expected to record its fifth consecutive surplus. This would bring our debt pay down to about $41 billion and bring the debt-to- GDP ratio to just under 50%. It would also move us to having the third lowest debt-to-gdp ratio among the G-7 countries. In 1999, we were the second highest. 25

26 Reasons for Stabilization Funds Non-renewable resource revenues Achievement of fiscal targets Saving to address longer-term needs Lastly we come to saving to address longer-term needs as a reason for establishing a stabilization fund. Before I proceed, I should just clarify that while I did mention savings funds in the first section dealing with non-renewable resource revenues, this was in the context of a depleting asset. Here I will be speaking about savings funds in a broader sense. 26

27 Saving to address long-term needs Stabilisation funds used as savings funds Many countries will experience a significant ageing of their populations over next decades Funds used to create store of wealth for future generations; draw down assets when long-term spending pressures emerge As I just mentioned, stabilisation funds have been established to help ensure that longer-term expenditure needs will be met. Indeed, funds in this case can be more properly thought of as savings funds. These types of funds have become more prevalent as countries prepare for the ageing of their population over the next decades. Essentially, these funds are used to create a store of wealth for future generations. The idea here is that a stock of assets will be accumulated and then drawn down as spending pressures emerge. 27

28 Establishing savings funds Most common motivation pre-fund long-term pension expenditure Generally, governments accumulate private financial assets and in some cases decide investment strategy There is considerable interest today in accumulating assets to pre-fund long-term pension expenditure. In general, in establishing these funds, governments accumulate private financial assets and in some cases they actually decide the investment strategy. Of course, there are some contentious issues here. First, one could ask, is it appropriate for government to invest in private sector companies?. Apart from this being a philosophical question, this is a concern given that large-scale investment could distort capital market operation. Second, the independence of political considerations in managing the investment portfolio is paramount. The key issue here is how the board of directors (responsible for managing the portfolio) is selected and how the law defines their responsibilities. Lastly, ensuring transparency and accountability is essential for securing public acceptance and maintaining confidence. This of course involves regular and comprehensive reporting on the funds. 28

29 Effectiveness of savings funds Effectiveness is difficult to assess given that real test will occur as age-related public expenditure pressures arise over the long-term To be effective savings funds must raise overall national savings. Risk that increased savings in one area will be offset by reduced savings elsewhere While it is relatively straightforward to assess the effectiveness of non-renewable resource funds and funds used to achieve fiscal targets, it is more difficult to directly assess the effectiveness of the ability of savings funds to meet long-term expenditure pressures since the real test will be years or decades away. However, we do know that in order for savings funds to be successful, they must raise overall national savings. Of course an increase in public sector saving could be offset by a reduction in private sector saving through Ricardian Equivalence. But the main risk here I think is within the government sector itself as increased savings in one area could be offset by reduced savings in another. Thus simply establishing a savings fund will not automatically guarantee increased national savings. 29

30 Some examples of savings funds US Federal Retirement Thrift Investment Board New Zealand Superannuation Fund Kuwait Reserve Fund for Future Generations Now I will turn briefly to some international examples of savings funds. In the US there is the Federal Retirement Thrift Investment Board. This board oversees a voluntary defined contribution retirement plan for federal employees. This board may only invest passively (through index funds for equities) and day-today management is carried out by outside fund managers. In New Zealand, there is the Superannuation Fund that was established in This special investment fund was set up to soften the future impact on taxpayers and government spending. The Government contribution to the fund is calculated annually based on legislated formula and this formula aims to ensure the capital contribution takes the next 40 years' superannuation costs into account. In Kuwait, there is the Reserve Fund for Future Generations which was established in Now I have included the Kuwaiti fund in this section of my presentation because while Kuwait has significant natural resource revenue, its fund operates irrespective of the price of oil or budgetary developments. This fund, which invests entirely in foreign assets is designed to save in order to provide stream of income for future generations. Gov t contributes 10% of total revenue regardless of the price of oil or the budget balance. 30

31 Canada Pension Plan (CPP) Investment Fund Review of CPP in 1996 showed insufficient assets to meet long-term obligations 1997: federal and provincial finance ministers agreed to raise contribution rates to generate funds in excess of those required to pay pensions until at least 2021 Excess contributions and proceeds from maturing bonds (held by the CPP) invested in private assets Canada also provides a good example of a savings fund the Canada Pension Plan (CPP) Investment Fund. The Canada Pension Plan has been around since It is an employee and employer contributory program. Until 1996, surpluses in the Plan were borrowed by provincial governments. However, in 1996, the CPP Investment Board was conceived as a result of a public review commissioned by federal and provincial finance ministers to ensure that the Plan would be affordable and sustainable. As a result of the public review, in 1997, the finance ministers agreed to raise contribution rates to levels that will generate funds in excess of those required to pay pensions until at least In 2003, the legislated contribution rate is scheduled to reach its peak at 9.9%. To ensure that the funds earn maximum returns until they are needed, the ministers created the CPP Investment Board, an independent investment corporation, to invest the excess contributions and the proceeds from maturing bonds (held by the Canada Pension Plan) in private assets. 31

32 Canada Pension Plan (CPP) Investment Fund CPP Investment Board s legislated mandate: to invest in the best interests of CPP contributors and beneficiaries and to maximize long-term returns without undue risk of loss Regulations can be established or changed only with the support of the federal government and 2/3 of the participating provinces representing 2/3 of the population The CPP Investment Board s legislated mandate is to invest in the best interests of CPP contributors and beneficiaries and to maximize long-term returns without undue risk of loss. Regulations allow the Board to invest in any asset they think is appropriate, such as stocks, bonds and real estate. They can invest actively or passively. They can also invest within Canada and internationally subject to the foreign property rule, which limits foreign assets at cost to 30 per cent of the total portfolio. In terms of establishing or changing regulations, support of the federal government and 2/3 of the participating provinces (Quebec has its own public pension plan) representing 2/3 of the population is required. While I mentioned before that it is difficult to measure the effectiveness of savings funds, I should note that at least based on actuarial projections, the long-term viability and sustainability of the Canada Pension Plan has been confirmed by our Chief Actuary in his latest report. In fact, the steady-state contribution rate (which is the lowest rate sufficient to sustain the Plan without further increases) was estimated at 9.8%, slightly below the maximum legislated rate of 9.9%. 32

33 Conclusion Fiscal Stabilization Funds are established for various reasons: Reduce fluctuations in budgetary revenue Aid in the achievement of short-term term fiscal targets Address long-term spending pressures While Stabilization Funds can help policy makers achieve their goals, they are not the only means by which to achieve their objectives. Governments create fiscal stabilization funds for several reasons, including: To reduce fluctuations in budgetary revenue To help achieve short-term fiscal targets and to prepare for long-term spending pressures While stabilization funds can help policy makers achieve their goals, they are not the only means by which to achieve their objectives. Fiscal rules and a strong political commitment are also key in achieving objectives. 33