Fiscal Policy and Crowding Out in Developing Asia

Seok-Kyun Hur,Donghyun Park,Sushanta Mallick

doi:10.1068/c12185r

Abstract

Fiscal stimulus programs have contributed substantially to developing Asia's faster and stronger-than-expected recovery from the global financial crisis. This may lead to political pressures for greater use of countercyclical fiscal policy in the postcrisis period. However, the countercyclical effectiveness of fiscal policy depends critically on the extent to which it crowds out private investment and consumption. In the medium term, the use of fiscal policy to promote rebalancing toward domestic demand may require a moderate fiscal expansion. The extent of crowding out will impinge upon the effectiveness of such fiscal expansion in boosting domestic demand. In this paper we perform empirical analysis on both cross-country panel data and country-specific time-series data to investigate crowding out in the region. Overall, our empirical evidence is decidedly mixed, with no clear evidence of either crowding out or crowding in. The evidence fails to provide compelling support for greater use of fiscal policy for countercyclical purposes. In the context of rebalancing, fiscal expansion will not, in and of itself, contribute to a more balanced demand and output structure. That would require using fiscal policy to help remove structural impediments to private consumption and investment.

Highlights

Developing Asia’s growth performance was hit hard by the contraction of global trade during the peak of the crisis in the 4th quarter of 2008 and 1st quarter of 2009, it has staged a spectacular V-shaped recovery since
The central objective of this paper is to empirically examine whether fiscal policy crowds out private consumption and investment in developing Asia
The impact of fiscal policy on output depends to a large extent on whether or not fiscal expansion crowds out private consumption and investment

Summary

Introduction

Developing Asia’s growth performance was hit hard by the contraction of global trade during the peak of the crisis in the 4th quarter of 2008 and 1st quarter of 2009, it has staged a spectacular V-shaped recovery since . The regionwide fiscal response was entirely appropriate given the likely prospect of a severe and protracted recession hanging over the region It was uncharacteristic and unusual in light of the region’s long-held reluctance to use fiscal policy for countercyclical macroeconomic stabilization. On the other hand, public spending does not displace private demand at all or crowds in additional private demand, fiscal policy would be a highly effective countercyclical tool. The central objective of this paper is to empirically examine whether fiscal policy crowds out private consumption and investment in developing Asia. Our empirical evidence from both crosscountry panel data and country-specific time-series data indicate that fiscal expansion does not have a significant negative effect on private consumption and investment in the region.

Fiscal Policy and Crowding Out: A Brief Conceptual Overview

Crowding Out

Crowding-Out

Findings

Concluding Observations