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Comments on Antonio Fat ás Luis Servén The World Bank Workshop on fiscal policy IMF, June 2009

Comments on Antonio Fat ás Luis Servén The World Bank Workshop on fiscal policy IMF, June 2009. Automatic stabilizers. Three components of fiscal policy: Automatic Systematic discretionary Purely discretionary (i.e., unsystematic)

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Comments on Antonio Fat ás Luis Servén The World Bank Workshop on fiscal policy IMF, June 2009

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  1. Comments on Antonio Fatás Luis Servén The World Bank Workshop on fiscal policy IMF, June 2009

  2. Automatic stabilizers Three components of fiscal policy: • Automatic • Systematic discretionary • Purely discretionary (i.e., unsystematic) • and (2) hard to separate: formal explicit rules vs implicit ones -- routine responses to economic conditions. Most research has focused on identifying the effects of (3). But it likely accounts for a relatively small fraction of the overall variation in fiscal variables – as implied by high R2 from projecting them on cyclical and other factors. Nice to see (1) get some attention too.

  3. Automatic stabilizers: measurement • Typical ingredients: • Direct taxes (+ SS contributions) • Indirect taxes • Unemployment benefits • Measurement • Using tax codes, unemployment rules etc (hard) • Regression of fiscal outcomes on cycle (easier) • Reverse causality – with no obvious instruments • Mixes up all systematic policies – not only automatic

  4. Automatic stabilizers: measurement Different in poor countries: smaller government, conventional stabilizers weak on the revenue side, and virtually absent on the expenditure side. Source: WDI

  5. Automatic stabilizers: measurement Latin America vs industrial countries Source: Suescún 2007

  6. Automatic stabilizers: measurement Regressions of fiscal aggregates on cyclical indicators. • Lump together all systematic policy (automatic + dicretionary) • Hard to interpret due to reverse causality (Rigobón 2004) • Typical finding is (more) pro-cyclical policy in poor countries, acyclical / counter-cyclical in rich ones – survives a variety of robustness checks (Ilzetzki and Végh 2008) • Why? • Financial frictions: procyclical access to borrowing (Gavin-Perotti 1997; Kaminsky-Reinhart-Végh 2004) • Institutional failures (Tornell-Lane 1999, Talvi-Végh 2005, Alesina-Tabellini 2005, Ilzetzki 2007…) Some empirical support for both explanations – although based on crude measures of institutional quality and access to finance.

  7. Calderón & Schmidt-Hebbel 2008: most of the action seems to come from institutional differences. Automatic stabilizers: measurement Dependent variable: public consumption growth IV estimates, 121 countries, annual data (WDI dataset) A closer look at LDC fiscal institutions could be illuminating.

  8. Automatic stabilizers: measurement But also: shocks in developing countries may be different. Aguiar-Gopinath 2007: • Industrial countries: transitory shocks and stable trend • Developing countries: trend shocks (“the trend is the cycle”): a current shock signals an even bigger future change in the same direction If optimal policy is forward-looking, its response to current output changes (the focus of conventional regressions) may well be different in industrial and developing countries.

  9. Automatic stabilizers: effectiveness Effectiveness usually stated in terms of output stability – but consumption stability at least as important. Methodologically, assessing effectiveness of automatic stabilizers is different from evaluating unsystematic policies: it involves evaluating rules – Lucas critique. In principle one would need structural models with policy-invariant behavioral relations (like McCallum 1999 on systematic monetary policy). Not many such exercises (Andrés, Doménech & Fatás 2008 is one) Instead, reduced-form regressions of aggregate volatility on measures of cyclical response of budget – or even government size.

  10. Automatic stabilizers: effectiveness The relation between volatility and government size is different outside rich countries Source: Perry, Servén and Suescún 2007

  11. Automatic stabilizers: effectiveness • Why does government size work differently in developing countries? -- Nonlinearities: poor countries are below a “minimum government size” for the stabilizing effect to occur (the reverse of Buti et al 2003 for rich countries) -- Composition effect: automatic stabilization is overwhelmed by procyclical discretionary policy -- Shocks are different (as before) Worth a closer look.

  12. Automatic stabilizers: effectiveness Automatic stabilizers vs discretionary policy Some hints that the latter may be partly replacing the former since the 1990s (e.g., Debrun et al 2008, Auerbach 2009) – is that a good idea? Not so clear that “automatic stabilizers are more effective” – what is the metric and evidence? They do offer the advantages of speed, predictability and reversibility – especially valuable when fiscal institutions are weak Aside from efficiency issues, the political economy of automatic stabilizers can be hard too: income taxation, tax enforcement etc – still big hurdles for many developing countries.

  13. End

  14. Source: Auerbach 2009

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