thorvaldur gylfason international monetary fund/asian development bank course on financial...
Post on 28-Dec-2015
215 Views
Preview:
TRANSCRIPT
Thorvaldur GylfasonInternational Monetary Fund/Asian Development
Bank Course on Financial Programming and Policies
Seoul, Korea, 17-28 May 2010
1. Objectives of fiscal policy Stabilization, allocation, distribution
2. Global financial crisis and fiscal policy response
Benefits associated with fiscal policy
3. Risks associated with fiscal policy
Public debt dynamics Sustainability of public debt Safeguarding fiscal sustainability
1. The term fiscal policy fiscal policy refers to the use of public finance instruments to influence the working of the economic system to maximize economic welfare
2.2. Effects of fiscal policy Effects of fiscal policy reflect not only the impact of the fiscal balance, but also various elements of taxation, spending, and budget financing
3. Assessing the stance of fiscal policy stance of fiscal policy requires taking account of the activities of allall levels of government
Vito Tanzi
1. StabilizationFiscal policy influences aggregate demandaggregate demand
Directly because Y = C + I + G + X – Z Indirectly because C depends on income after taxafter tax
Through demand, fiscal policy affects output, employment, inflation, balance of payments
2. AllocationFiscal policy also influences aggregate supplyaggregate supply
Public infrastructure, education, health care
3. DistributionThrough taxes, transfers, and expenditures Progressive, neutral, regressive
Fiscal policy can be used to several ends To achieve internal balanceinternal balance
By adjusting aggregate demand to available supply By achieving low inflation, potential output
To promote external balanceexternal balance By ensuring sustainable current account balance By reducing risk of external crisis
To promote economic growtheconomic growth E.g., through more and better education and health care
Fiscal policy needs to be coordinated with monetary, exchange rate, and structural – i.e., supply-side – policies
Demand managementE.g., lower income
taxes Aggregate supplyin short run
Aggregate demand
Pri
ce level
Output
A
B
Demand managementE.g., lower income
taxes
Supply managementE.g., lower import tariffs
Aggregate supplyin short run Aggregate supply
in short run
Aggregate demand
Aggregate demand
Pri
ce level
Pri
ce level
Output Output
A
B
B
A
National income accounts Y = C + I + G + X – ZY = C + I + G + X – Z S = Y – T – C = I + G – T + X – Z, soS = Y – T – C = I + G – T + X – Z, so G – T = S – I + Z – X G – T = S – I + Z – X
Government budget deficit must be financed either by (a) having private saving in excess of private investment or (b) by accumulating foreign debt through a deficit in the current account of the balance of payments, or both
Alternative formulation G – T = G – T = B + B + DDGG + + DDFF
Government budget deficit must be financed by borrowing either at home or abroad, i.e., from (a) the public, (b) the banking system, or (c) foreigners
Y = GDPC = ConsumptionI = InvestmentG = Government expenditure (plus lending minus repayments)T = Taxes (plus grants)X = ExportsZ = ImportsB = Government bonds outstandingDG = Credit from banking systemDF = Credit from foreigners
Inflationary vs.
noninflationary
finance
Central bank financing involves money money creationcreation Inflation taxInflation tax: Most inflationary form of financing
Bond finance is less inflationary Removes financial resources from circulation Increases real interest rates Crowds out private investment
External financing can be inflationary Especially if it leads to currency depreciation
Evidence from cross-country data Strong links between budget deficits and inflation
in developing countries, but not in industrial countries
Bond finance is the rule in industrial countries … … and money finance is the exception
Conventional budget surplus T – GT – G
Large in upswings when tax base (YY) is strong Small in downswings when tax base is weak
Full-employment surplus TTFEFE – G – G
Use tax revenue as it would beat full employment
Independent of business cycles A budget in deficit could be in
surplus with full employment Deficit can be consistent with
a tight fiscal stance fiscal stance (see chart)
T, G
YYFEY < YFE
T
G
Problem here is not
that deficit is too
large but that income
is too lowEconomic expansion
would automatically
turn deficit into
surplus
Public sector borrowing requirementBroad measure of public sector deficit,
including central, state, and local government Primary budget balance
Leaves out interest payments Conventional deficit = G – T = GN + GI – T = GN + iDG
- T Primary deficit = GN – T = G – T – iDG
GN = Noninterest expenditureGI = Interest expenditurei = Nominal interest rateDG = Government debt outstanding
Operational deficitLeaves out inflation component of interest
payments Operational deficit = conventional deficit minus
inflation componentinflation component of interest payments = primary deficit plus real component real component of interest payments
Conventional deficit: G – T = GN + iDG – T = GN + (r + )DG – T
Operational deficit: G – T - DG = GN – T + rDG
Hence, operational deficit includes only real real part part of interest payments, leaves out the inflation partinflation part
GN = Noninterest expenditureGI = Interest expenditurer = Real interest rateDG = Government debt = Inflation rate
r ≈ i -
Before Great Depression 1929-39, many thought that governments needed to balance their budgets from year to year
Even so, US had built is railways through borrowing, for example
Keynes revolted (General Theory 1936) If private sector failed to consume and invest,
government could fill the gap Y = C + I + G + X – ZY = C + I + G + X – Z CC and II and GG appear side by side Guns or butter? Makes no difference Also, could reduce taxes to encourage CC and II
Multiplier analysis It could be shown that, with unemployed
resources, an increase in G would raise Y by an amount greater than the original increase in G
Active fiscal policy was used consciously in Sweden even before Keynes …
… and adopted in US and elsewhere after 1960 (Kennedy-Johnson administration) Coincided with buildup of US as a welfare state
with greater emphasis on public services and social security, like in Europe
Active fiscal policy came naturally to Europe
Fiscal policy can affectAggregate demand, output, and price level
Cut taxes: Consumption, output, and prices riseRate of monetary expansion and inflation
Increase spending financed by credit expansion: Money expands (M = D + RM = D + R), so inflation goes up
Aggregate supply and economic growth Boost education and health care: Efficiency and
long-run growth go upCurrent account of balance of payments
Raise taxes: Disposable income and imports fall, so current account improves unless currency appreciates
Fiscal multipliers are positive, but small Impact of fiscal policy actions depends on
Whether economy is open or closed (import leakage) Exchange rate regime (fixed or floating) Type of budget financing (money creation or debt) Degree of confidence in economic policy
Level of government debt Financing constraints Risk premia on debt
Whether fiscal changes are considered temporarytemporary or permanentpermanent
How close the economy is to full employment
Expenditure Income Interest Rate(+) (+)
Consumption
Investment
Tax revenue
(+)
(-)
(-)Gov’t BudgetBalance
(+) (-)
RE(+)
(+)
Capital
Labor
(+)(+)
Fiscal Policy
(+)
(-)
(-)
Monetary policy has been used heavily
Its further impact may be limitedIn many countries, policy interest rates
already approach zeroMonetary policy may have limited effect
during “balance sheet recessions,” when many firms are technically bankrupt, will use increased earnings to restore capital, and may not respond to lower interest rates Koo (2009), Holy Grail of Macroeconomics: Lessons from
Japan’s Great Recession
Mixed evidence on efficacy of fiscal policy in developing countries
While automatic stabilizing impulses are weak and make the case for discretion, there is also the widely noted occurrence of pro-cyclicality
The focus of stimulus packages differ between advanced and developing countries
Infrastructure spending 46% of fiscal stimulus in developing economies, but 15% in advanced economies
Tax cuts over 34% of fiscal stimulus in advanced economies, only 3% in developing economies Khatiwada, S. (2009), “Stimulus Packages to
Counter Global Economic Crisis; A Review,” International Institute for Labour Studies Discussion Paper 196.
No clear consensus among economists about the size of fiscal multipliers (response of real GDP to tax cuts or higher spending)
Recent IMF Staff Position Note reports: A rule of thumb is a multiplier (using the definition ΔY/ΔG and
assuming a constant interest rate) of 1.5 to 1 for spending multipliers in large countries, 1 to 0.5 for medium sized countries, and 0.5 or less for small open countries.
Smaller multipliers (about half of the above values) are likely for revenue and transfers while slightly larger multipliers might be expected from investment spending.
Negative multipliers are possible, especially if the fiscal stimulus weakens (or is perceived to weaken) fiscal sustainability.
Source: Spilimbergo, Symansky, and Schindler (2009), “Fiscal Multipliers,” IMF Staff Position Note spn/09/11.
Countries Countries Amount in Amount in
US$ (billion) US$ (billion)
As a % GDP As a % GDP Fiscal balance 2009 Fiscal balance 2009 (% of GDP, est.)(% of GDP, est.)
Japan 774 16.4 -6.8 China 586 14 -3.1 S. Korea 86 12.8 -2.1 Singapore 13.8 10.7 -3.5 Malaysia 18.1 10 -7.4 Thailand* 3.3 1.2 -4.0 Indonesia 6.1 1.2 -2.6 Philippines 6.5 4.6 -3.2 Vietnam* 17.6 22 -7.0 Cambodia 0 0 -3.2
*Financing of Vietnam and Thailand’s second stimulus packages have been excluded as financing is yet to be finalized.
23
CountriesCountries Debt (% of GDP)Debt (% of GDP) China 16 Hong Kong 14 Indonesia 30 Japan 170 Korea 33 Malaysia 43 Philippines 56 Singapore 114 Thailand 42 Vietnam 39
Source: ADB.
SolvencySolvency Satisfying solvency condition
LiquidityLiquidity Ability to meet maturing obligations
SustainabilitySustainability Solvency + liquidity + no expectation of unrealistically large adjustment
VulnerabilityVulnerability Risk of insolvency or illiquidity
Monetary surveyM = R + DD = DG + DP
Fiscal policy determines government’s demand for bank financing (DDGG), which, in turn, affects total domestic credit (DD), i.e., net domestic assets (ignoring other items net), and money (MM)
Increased budget financing requires greater monetary expansion unless credit to private sector (DDPP) is cut or foreign reserves (RR) go down, reflecting weaker balance of payments position
M = Money supplyR = Reserves (NFA)D = Domestic credit (NDA)DG = Domestic credit to governmentDP = Domestic credit to private sector
In times of financial and economic crisis, fiscal policy plays key role in government’s response
Fiscal policy played a role during Great Depression, even if theory behind it was poorly understood, or even disputed
Fiscal policy plays key role in current crisis Monetary policy is ineffective if real interest
rates cannot be reduced without igniting inflation
Fiscal policy is more effectiveMassive fiscal stimulus in US, Europe, and Asia: it
works!Fiscal stimulus is assisted by automatic stabilizers
Fiscal stimulus packages need to include an exit strategy exit strategy to ensure that solvency is not at risk, and should
Not have permanent effects on budget deficitsProvide a commitment to fiscal correction,
once economic conditions improve Include structural reforms to enhance growthShould firmly commit to clear strategies for
health care and pension reforms in countries facing demographic pressures
Need for financing tends to lift interest rates, so capital flows in and currency tends to appreciate
Central Bank must offset incipient appreciation by expanding money supply, thereby reinforcing initial fiscal stimulus
Otherwise, exchange rate could not remain fixed Fiscal stimulus works
under fixed exchange
rates
Need for financing tends to lift interest rates, so capital flows in and currency appreciates
Appreciation reduces net exports, aggregate demand, and interest rates
Process continues until interest rates fall to their initial level
So, fiscal stimulus is ineffective with perfect capital mobility
But concertedconcerted
fiscal stimulus can
work even
under floating
exchange
rates
In times of large deficits and growing large deficits and growing public debtpublic debt, public spending can have weak or even negative effectsBy creating expectations of a fiscal fiscal
crisiscrisis, and hence of higher future taxesIncreased saving may lead to a sharp fall
in consumptionHence, fiscal stimulus can fail, and may
even prove counterproductiveConversely, fiscal contraction may prove
expansionaryRicardian equivalence
Fiscal policy is frequently key to addressing balance of payments problems
Simple mechanismM = R + D M = R + D means R = R = M – M – D = D = M – M – DDGG – – DDPP
Hence, given MM and DDPP, key to raising RR is reducing DDGG
IMF: It’s Mostly Fiscal!
Or look at it this way:Y = C + I + G + X – Z Y = C + I + G + X – Z means
X – Z = Y – C X – Z = Y – C – T– T – I – G – I – G + T+ T = S – I + T - G = S – I + T - GHence, current account balance (X – ZX – Z)
equals sum of private sector surplus of saving over investment (S – IS – I) and government surplus of taxes over public expenditure (T – GT – G)
Equivalently, Z – X = I – S + G – T Z – X = I – S + G – T means that external deficit equals sum of private sector deficit and government budget deficit
Unsustainable fiscal policy can trigger a crisis if public loses confidence in government’s macroeconomic policy
Sudden capital outflow can result, weakening balance of payments and leading to a sharp devaluation
Financing the budget externally builds up external debt, increasing risk of crisis
Fiscal sustainability thus matters not only for debt, but also for balance of payments
Fiscal contraction (spending cuts, tax increases) can slow down inflation, reduce current account deficit
Fiscal expansion (tax cuts, spending increases) can shrink unemployment, increase aggregate demand and help restore output to full capacity, i.e., bring actual GDP up to potential GDP, especially if monetary policy is impotent
Automatic, or built-in, stabilizers are revenue or expenditure provisions that have counter-cyclical impact withoutwithout need for policy intervention
Protect against shocks Dampen business cycles
ExamplesProgressive taxes on income, profits Price stabilization fundsUnemployment insurance
Canada had no major bank
failures during Great
Depression, and did not
establish its Deposit
Insurance Corporation until
1967
How about the U.S. next
door?
Change in Canada’s per capita GDP from year to year 1871-2003 (%)
Change in US per capita GDP from year to year 1871-2003 (%)
Perhaps bank regulation during
Great Depression also helped
stabilize GDP
Change in UK per capita GDP from year to year 1871-2003 (%)
Not quite as clear, but standard deviation of per
capita growth fell from 3.1% 1831-1945 to 1.8%
1947-2003
Perhaps bank regulation during
Great Depression also helped
stabilize GDP
Change in French per capita GDP from year to year 1821-2003 (%)
Perhaps bank regulation during
Great Depression also helped
stabilize GDP
Change in German per capita GDP from year to year 1851-2003 (%)
Perhaps bank regulation during
Great Depression also helped
stabilize GDP
Perhaps bank regulation during
Great Depression also helped
stabilize GDP
Source: Maddison (2003).
Change in Swedish per capita GDP from year to year 1821-2003 (%)
Objections to fiscal activismBorrowing to finance increased government
expenditures raises interest rates, thereby crowding out crowding out investment and reducing multiplier
At full employment, increased public spending, however financed, leads to inflationinflation without stimulating output except temporarily
Increasing spending or cutting taxes to combat unemployment may impart inflation bias inflation bias to economic system Rules vs. discretion Long lags, including approval and implementation
Fiscal activism may tend to expand public public sectorsector
Government has vital role to play in modern mixedmixed economies (allocation role)
EducationHealth care, cf. current debate in United States Infrastructure (roads, bridges, etc.)
Some would also stress government’s distribution role …
… claiming that the government should try to secure reasonable equality equality in the distribution of income and wealth, including poverty poverty alleviationalleviation
Normative or positive economics? Partly positive: Equality is good for growth
Two views Inequality Inequality
sharpens sharpens incentives incentives and thus helps growth
Inequality Inequality endangers social endangers social cohesion cohesion and hurts growth
117 countries,1960-2000
-8
-6
-4
-2
0
2
4
6
10 20 30 40 50 60 70
Gini index of inequality
Pe
r ca
pita
gro
wth
ad
just
ed
for
intia
l in
com
e (
%)
r = -0.27
Equality is good Equality is good for growth for growth
No visible sign here that equality stands in the way of economic growth
An increase in Gini Gini indexindex by 16 points goes along with a decrease in per capita growth by one percentage point per year
-8
-6
-4
-2
0
2
4
6
10 20 30 40 50 60 70
Gini index of inequality
Pe
r ca
pita
gro
wth
ad
just
ed
for
intia
l in
com
e (
%)
r = -0.27
Why not raise government expenditure on public services or whatever and reduce taxes? – to buy votes
Supposing all objections could be swept asideBecause this would create a deficitdeficit and
deficits can lead to inflationinflation, and inflation is undesirable for many reasons – it reduces efficiency and growth, for one thing
Even so, a modest deficit can be sustained in a growing economy
So how modest is modest?
Debt accumulation is, by its nature, a dynamicdynamic phenomenon A large stock of debt involves high
interest payments which, in turn, add to the deficit, which calls for further borrowing, and so on o Debt accumulation can develop into a
vicious circlevicious circle How do we know whether a given
debt strategy will spin out of control or not?o To answer this, we need a little
arithmetic
Recall operational budget deficit:G – T = G – T = B + B + DDGG + + DDF F = = D D = G= GNN + +
rD - T rD - T where DD is total government credit
outstanding Further, assume for simplicity
T = GT = GNN
Then, we haveD D = rD= rD
This gives
rD
ΔD
But what is
This is proportional change in debt ratio:
Y
ΔY
D
ΔD ??
YDYD
Δ
Y
ΔY
D
ΔD
This is an application of a simple rule of arithmetic:
%%(x/y) = (x/y) = %%x - x - %%yy
z = x/ylog(z) = log(x) – log(y)
log(z) = log(z) = log(x) - log(x) - log(y)log(y) But what is log(z) log(z) ?
So, we obtain
z
Δz
z
1
dt
dz
dt
dlog(z)Δlog(z)
y
Δy
x
Δx
z
Δz
Q.E.D.
We have shown that
grd
Δd
where
Debt ratio
Time
r r g g
r = gr = g
r r g g
Deficits can be Deficits can be
sustained as long as sustained as long as
debt ratio does not spin debt ratio does not spin
out of control – i.e., at out of control – i.e., at
least as long as g least as long as g >> r r
Y
Dd
We have shown that
grd
Δd
where
Debt ratio
Time
r r g g
r = gr = g
r r g g
Need economic Need economic
growth to keep growth to keep
debt ratio under debt ratio under
controlcontrol
Y
Dd
We have shown that
grd
Δd
where
Debt ratio
Time
r r g g
r = gr = g
r r g g
Higher interest Higher interest
rates can turn a rates can turn a
sustainable debt sustainable debt
position into an position into an
unsustainable oneunsustainable one
Y
Dd
Take another look Intertemporal budget constraint:
Dividing by nominal GDP (= PY), we get
1
1
1 1
1
1 1t tt
tt t t
t t t t t t t t
d pbd
iD D PB
PY g P Y PY
tt-t PBDiD 1t 1
Primary deficit = GN – T = G – T – iDG
Primary balance: PB = T – G + iDG
tt-t
tt pbd
g
rd
11
1 If r > g, d rises over time
If r = g, d remains unchanged
If r < g, d declines
t
tt
ir
1
11
We have seen that
To find where debt ratio is headed, i.e., the long-run equilibrium value of d, we set dt = dt-1; this gives
tt-t
tt pbd
g
rd
11
1
tt
ttt rg
pbgd
)1(
> 0 if pb < 0 and g > r
pb < 0 means that
primary budget balance
is in deficit
Reducing primary deficit is
key to reducing
debt ratio
Sound fiscal policy is critical for good macroeconomic management, and can help manage capital flows
Fiscal stimulus is usually expansionary, but not invariably
Fiscal policy crucially affects BOP, and interacts with monetary policy
Fiscal policy, as before, is crucial to responding to financial crisesEspecially when monetary policy lands in
liquidity trap and loses traction Fiscal policy can help foster rapid growth
top related