Fiscal Policy Responses Research Articles

Fiscal Policy Response to External Crises the Case of Moldova 1998-2010

External shocks pose major challenges to fiscal policy makers through lower output and large fiscal imbalances. This paper analyzes the case of Moldova, which faced parallel crises a decade apart: the Russian crisis of 1998 and the global financial crisis of 2008-2009. The country went through large fiscal adjustments during these crises and launched important fiscal reforms. The paper reviews the crises and reform experience. In particular, it aims to explain the motivation for reforms, describe reform design and implementation, and provide an understanding of their outcomes. The paper also catalogues the form and size of international assistance for Moldova.

Fiscal Policy Response to External Crises the Case of Moldova 1998-2010

External shocks pose major challenges to fiscal policy makers through lower output and large fiscal imbalances. This paper analyzes the case of Moldova, which faced parallel crises a decade apart: the Russian crisis of 1998 and the global financial crisis of 2008-2009. The country went through large fiscal adjustments during these crises and launched important fiscal reforms. The paper reviews the crises and reform experience. In particular, it aims to explain the motivation for reforms, describe reform design and implementation, and provide an understanding of their outcomes. The paper also catalogues the form and size of international assistance for Moldova.

Ghana: Fiscal Policy Responsiveness, Persistence and Discretion

Fiscal policy involves the use of government spending and taxation to influence the level and direction of economic activity in an economy. Fiscal policy affects aggregate demand, the distribution of wealth, and the economy’s capacity to produce goods and services. The objective of the paper is to assess how fiscal policy is influenced by output conditions, past fiscal policy measures and the discretion of fiscal authorities. We therefore employ Two Stage Least Squares (2SLS) to decompose fiscal policy in the context of both revenue and spending into its principal components – responsiveness, persistence and discretion. The results show that while government revenue is more responsive to output conditions than government spending, government expenditure is more persistent than government revenue. We also found that fiscal authorities in Ghana have generally low discretion. We think that while an upward adjustment in rates, fees and user charges that raises nontax revenue above 20 percent of domestic revenue would help reduce the responsiveness of government revenue to output conditions, a downward revision of some statutory payments especially the District Assemblies Common Fund (DACF) and a thorough review of others such as GETFund and NHIL could help in introducing some dynamism in fiscal policy setting with the possibility of reducing the existence of fiscal deterioration in the long term

Oil prices and the fiscal policy response in oil-exporting countries

This paper empirically investigates the role that oil prices play in determining fiscal policy in oil-exporting countries. We derive and estimate a fiscal policy equation that links government spending not only to oil price shocks, but also to oil price volatility and the skewness of oil price changes. We find that in the long run, higher oil prices induce larger government size. In the short run, however, government expenditures rise less than proportionately to the increase in oil revenues, reflecting increasing prudence in fiscal policy in oil producing countries. This result is robust to using a variety of specifications of the oil price shock, and to using different sample periods.

An Exploration of Optimal Stabilization Policy

This paper examines the optimal response of monetary and fiscal policy to a decline in aggregate demand. The theoretical framework is a two-period general equilibrium model in which prices are sticky in the short run and flexible in the long run. Policy is evaluated by how well it raises the welfare of the representative household. While the model has Keynesian features, its policy prescriptions differ significantly from textbook Keynesian analysis. Moreover, the model suggests that the commonly used bang for the buck calculations are potentially misleading guides for the welfare effects of alternative fiscal policies.

On the Macroeconomic Management of Food Price Shocks in Low-income Countries

Global food prices have risen sharply in recent years and have become more volatile. In this paper, I examine how these developments are transmitted to domestic food and non-food markets in low-income economies and consider the options available to policymakers concerned with managing the macroeconomic consequences of global food price shocks. I first review the simple economics of the transmission of global food price movements to food and non-food prices in low-income countries. I then use a simple dependent-economy model to illustrate the real macroeconomic and distributional effects of alternative fiscal and trade policy responses to food shocks and how these are determined by the structural characteristics of low-income economies. In the final section, I consider how food price shocks impact on the aggregate price level and, in particular, the implications of increased food price volatility has for the design and conduct of monetary policy in low-income economies.

Changes in the Terms of Trade and Sectoral Reallocation of Labor: The Case of Guyana, Jamaica, and Trinidad and Tobago

This paper quantifies the consequences of long-term changes in the terms of trade on the growth rate of real income in Guyana, Jamaica, and Trinidad and Tobago. We find that magnitudes of both the long-term changes in the terms of trade and the responses of income growth rates vary considerably across these three countries. We then develop a model that links a change in the terms of trade to a change in income through the degree of sectoral reallocation of labor. Using this model, we analyze whether specific fiscal and trade policy responses cushion or amplify the impact of terms of trade on income. In a calibrated version of the model, we demonstrate that the degree with which an economy reallocates its labor across sectors is not necessarily a good indicator of its vulnerability to changes in its terms of trade.

An Exploration of Optimal Stabilization Policy

This paper examines the optimal response of monetary and fiscal policy to a decline in aggregate demand. The theoretical framework is a two-period general equilibrium model in which prices are sticky in the short run and flexible in the long run. Policy is evaluated by how well it raises the welfare of the representative household. Although the model has Keynesian features, its policy prescriptions differ significantly from those of textbook Keynesian analysis. Moreover, the model suggests that the commonly used “bang for the buck” calculations are potentially misleading guides for the welfare effects of alternative fiscal policies.

Israel: 2010 Article IV Consultation--Staff Report; Public Information Notice on the Executive Board Discussion

Israel was mildly affected by the global recession: following a slowdown in 2009, output is projected to grow by some 4 percent in 2010, led by consumption and exports. Robust fundamentals—including sustained pre-crisis fiscal consolidation—and a swift monetary and fiscal policy response to the external downturn allowed Israel to pass through the global recession relatively unscathed. The resilience of the economy has been strengthened by the adoption of new fiscal rules capping spending and deficits.

Fiscal Policy Responses to Oil Price Volatility in an Oil-Based Economy

Oil prices increased from 2004 to historic highs in mid-2008 but have fallen precipitously since then. What are the effects of this volatility on an oil-based economy like Kuwait? This article examines options for policy responses from an oil-based economy perspective. The impact of changes in domestic tax and subsidy policies on the Kuwaiti economy is estimated using a computable general equilibrium (CGE) model. Results show that for a set of scenarios aimed at raising government savings via tax increases or subsidy cuts, the least negative impact on household welfare is for the subsidy-reducing scenario, a reflection of efficiency gains due to reduced price distortions. The most negative effects follow from raising government savings via increases in price-distorting import tariffs and the introduction of a nonuniform value-added tax (VAT). Given the small share of non-oil activities in Kuwait’s non-oil gross domestic product (GDP), the introduction of the VAT on non-oil activities does not generate a significant increase in government revenues.

Asymmetric Fiscal Dynamics and the Significance of Fiscal Rules for EMU Public Finances

Since the onset of the international financial and economic downturn, the issue of the sustainability of public finances has strongly repositioned itself at the center of economic policy debates, as a number of chronic fiscal ailments for many EMU countries still need to be effectively addressed for they pose new challenges for future economic policy. In this work we take stock of the fiscal situation in the EMU and attempt to dissect some of the most salient aspects of fiscal performance for a number of member states during the last decade, by concentrating on the evolution of key fiscal variables in a unified framework of analysis. We focus on the asymmetric evolution of public finances, in order to assess whether this has been the outcome of discretionary measures (including the massive stimulus packages as a response to the crisis) and the effects of automatic stabilizers or also due to poor fiscal management and lack of fiscal discipline within the existing institutional framework. The analysis is then taken a step further by estimating the requirements for long-term sustainability of public finances in the EMU member states in our sample. Within this context, the issue of the effectiveness of existing rules and institutions is addressed, as institutional arrangements are crucially related to fiscal performance. We conclude by highlighting the importance of adopting a cohesive and enabling framework for public finance stabilization and adjustment purposes. Our view is that since the root causes of fiscal problems in the Eurozone are diverse, responding to the diversity of fiscal challenges in a symmetric way i.e. applying a ‘one-size fits all’ EMU strategy, may prove sub-optimal for individual country fiscal sustainability objectives. In fact, fiscal policy responses will inevitably be asymmetric. This asymmetric evolution of public finances puts into question the sustainability objective and thus convergence of the EMU as a whole.

Weathering the Global Financial Crisis: Reflections on the Capacity of the Institutions of Australian Governance

The global financial crisis (GFC) of 2008 sent the economies of major developed nations into freefall. As credit markets froze and investor and consumer confidence collapsed to levels not seen since the Great Depression, governments clamoured to develop policies and interventions aimed at preventing wholesale economic meltdown. The Australian economy has come through the crisis relatively unscathed. In contrast to most other advanced economies, Australia avoided recession and, despite dire forecasts, has experienced only modest increases in rates of unemployment. Consumer confidence has recovered, investment is returning and the economy has performed consistently above expectations. What accounts for Australia's success in navigating the global financial crisis? Economists will emphasise the combination of monetary and fiscal policy responses – significant cuts to interest rates, large stimulus packages, bank guarantees and other stabilising measures that were rapidly deployed as the crisis unfolded; the underlying strength of the nation’s economy, surplus budgets, comparatively low rates of debt and effective prudential regulation. Each of these was undoubtedly crucial, but as this paper argues, features inherent to the institutions of Australian governance must also be taken into account. This paper examines the structures of advice and support to Australian decision-makers that enabled decisive action to be taken and decisions implemented as the financial crisis loomed. It highlights the significance of the economic policy settings established by successive Australian governments, supported by a cadre of economic advisers – career officials and partisans, whose experience and institutional memory proved valuable to the newly-elected Labor government. The paper argues that Australia's success owes much to timely and effective policy responses deployed quickly as the financial crisis loomed. The government's pre-emptive and aggressive response to the global financial crisis and the design of its fiscal policies was supported and enabled by an advisory system that had prepared for and which consciously drew on the lessons learned during earlier downturns. It concludes that the policy learning of key actors within the advisory and decision-making system was significant in helping to position Australia's economy to withstand the most significant economic shock since the Great Depression.

Fiscal Policy in the Crisis: Impact, Sustainability, and Long-Term Implications

The global economic and financial crisis has sparked an unprecedentedly large, generalized fiscal policy response in practically all major industrial and emerging economies, which will change the fiscal and macroeconomic landscapes for some time to come. This paper offers an overview of the new fiscal landscape looking at the following aspects: the size and composition of the fiscal stimulus packages of the major economies, the likely impact of such packages on aggregate demand and growth, the sustainability of countries’ fiscal positions, and the international implications of the new fiscal landscape. It then considers under which conditions a virtuous scenario could develop that combines strong and balanced growth with fiscal sustainability. Finally, it offers some conclusions and lessons that can be shared by European and non-European economies.

Macroeconomic Uncertainties, Oil Subsidies, and Fiscal Sustainability in Asia

Global oil prices have subsided relative to the peak reached in mid-2008, but compared to historical levels they remain elevated and volatile as economic uncertainties continue to unfold. The likelihood of these prices rising again soon cannot be ruled out. High oil prices can adversely affect growth, employment, external accounts, and fiscal positions of governments. An overwhelming response across Asia as international oil prices spiked in 2008 was to shield domestic consumers more than before through oil subsidies, which are inequitable, economically inefficient, and environmentally unfriendly. These subsidies add directly to the fiscal deficit and public debt, but are generally hidden, making their measurement difficult. Additionally, in combination with lower growth rates, higher spending to rev up demand across Asia is also worsening the fiscal positions of governments.This paper computes the transmission of recent global oil price movements to domestic markets and estimates oil price subsidies in a diverse group of 32 Asian economies. Using data for 18 of these countries and applying a forward-looking methodology for debt dynamics, the paper then examines the potential impact of responses to macroeconomic shocks and a possible rise in oil prices on public debt and estimates the fiscal correction needed to sustain debt at a steady-state level. Based on the findings from the empirical analysis, the paper extracts some guiding principles for fiscal policy responses to the economic shocks depending on country-specific circumstances.

Inflexible Wages and Prices? Evidence in the Current Recession

The 2008/9 recession period brought the most massive and quickest response of fiscal and monetary policy in modern economic history. At the same time, small businesses (that produce half of private GDP) exhibited the most rapid adjustments in wages, prices, and inventories recorded in the past 35 years of data collected by the National Federation of Independent Business. The notion of “sticky” wages and prices plays a key role in arguments favoring government intervention to rebalance supply and demand for labor and output. The faster wages and prices (and therefore employment and output) adjust to a “shock” to the economy, the less the need for government intervention.

The Indonesian Economy amidst the Global Crisis: Good Policy and Good Luck

The global economic crisis has caused economic collapse in many countries. Indonesia is obviously affected by this crisis, its export growth declined significantly. Nevertheless, the impact of the crisis on the Indonesian economy is relatively limited compared to other countries in the region, including Singapore, Malaysia and Thailand. This situation leads into a question of why the impact of the global crisis on the Indonesian economy is relatively limited so far. Is it because of the structure of Indonesia's trade or the effectiveness of Indonesia's fiscal policy and monetary response? This paper argues that at least there are two reasons why Indonesia's performance was relatively good. Firstly, it was due to the appropriate policy responses both from Bank Indonesia and the Indonesian government. Secondly, Indonesia's relatively small export share to GDP saved the country from the global financial crisis. This was more a case of good luck than deliberately planned economic policy strategy. Nevertheless, this paper indicates that exports are a source of Indonesia's economic growth. Exports have a large effect in supporting economic growth, albeit less stable compared to domestic demand. Because of this, a strategy safeguarding a balance between domestic economy and global orientation, such as becoming a part of a production network and promoting export-oriented growth, must be a part of the development strategy of the national economy.

Oil Windfalls in Ghana: A DSGE Approach

We use a calibrated multi-sector DSGE model to analyze the likely impact of oil windfalls on the Ghanaian economy, under alternative fiscal and monetary policy responses. We distinguish between the short-run impact, associated with demand-related pressures, and the medium run impact on competitiveness and growth. The impact on inflation and the real exchange rate could be moderate, especially if the fiscal authorities smooth oil-related spending or increase public spending's import content. However, a policy mix that results in both a fiscal expansion and the simultaneous accumulation of the foreign currency proceeds from oil as international reserves- to offset the real appreciation- would raise demand pressures and crowd-out the private sector. In the medium term, the negative impact on competitiveness resulting from Dutch Disease effects-could be small, provided public spending increases the stock of productive public capital. These findings highlight the role of different policy responses, and their interaction, for the macroeconomic impact of oil proceeds.

Oil Windfalls in Ghana: A DSGE Approach

We use a calibrated multi-sector DSGE model to analyze the likely impact of oil windfalls on the Ghanaian economy, under alternative fiscal and monetary policy responses. We distinguish between the short-run impact, associated with demand-related pressures, and the medium run impact on competitiveness and growth. The impact on inflation and the real exchange rate could be moderate, especially if the fiscal authorities smooth oil-related spending or increase public spending’s import content. However, a policy mix that results in both a fiscal expansion and the simultaneous accumulation of the foreign currency proceeds from oil as international reserves—to offset the real appreciation—would raise demand pressures and crowd-out the private sector. In the medium term, the negative impact on competitiveness—resulting from ”Dutch Disease” effects—could be small, provided public spending increases the stock of productive public capital. These findings highlight the role of different policy responses, and their interaction, for the macroeconomic impact of oil proceeds.

Fiscal Policy in Oil Producing Countries During the Recent Oil Price Cycle

This paper presents a detailed analysis of the average fiscal policy responses of oil producing countries (OPCs) to the recent oil price cycle. We find that OPCs worsened their non-oil primary balances substantially during 2003-2008 driven by an increase in primary spending. However, this trend was partially reversed when oil prices went down in 2009. We also find evidence that fiscal policy has been procyclical and has hence exacerbated the fluctuations in economic activity. In addition, we estimate that a small reduction in oil prices could lead to very large financing needs in the near future. Finally, we show that long-term fiscal sustainability positions in OPCs have worsened.

Kyrgyz Republic: Request for Disbursement under the Rapid Credit Facility-Staff Report; Staff Statement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Kyrgyz Republic

The Kyrgyz government faces challenges of political turmoil and inter-ethnic flare-ups. The fiscal policy response to the economic crisis is appropriate, but there are limits to the expansion. The balances between revenue and expenditure choices as well as a shortfall in donor budget financing have to be maintained. Debt sustainability requires near and medium-term fiscal consolidation. Monetary policy has to support the post-crisis economic recovery while guarding against signs of exchange rate or inflation pressures. The emphasis on improving governance, transparency, and safeguards is commended.