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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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Presentation Transcript
slide1
Comments on Antonio Fatás

Luis Servén

The World Bank

Workshop on fiscal policy

IMF, June 2009

automatic stabilizers
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.

automatic stabilizers measurement
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
automatic stabilizers measurement1
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

slide5

Automatic stabilizers: measurement

Latin America vs industrial countries

Source: Suescún 2007

automatic stabilizers measurement2
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.

calder n schmidt hebbel 2008 most of the action seems to come from institutional differences
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.

automatic stabilizers measurement3
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.

automatic stabilizers effectiveness
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.

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Automatic stabilizers: effectiveness

The relation between volatility and government size is different outside rich countries

Source: Perry, Servén and Suescún 2007

automatic stabilizers effectiveness1
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.

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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.

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