1 / 20

Effects of Fiscal Policy: A Survey

This survey explores the effects of discretionary fiscal policy on both closed and open economies. It examines the theoretical foundations, empirical evidence, and different potential instruments used in fiscal policy. The findings suggest that government purchases have a positive impact on GDP, while net taxes fall and the real effective exchange rate appreciates.

weitz
Download Presentation

Effects of Fiscal Policy: A Survey

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. A survey of the effects of discretionary fiscal policyStockholm, 29 January 2008 Roel Beetsma University of Amsterdam, CEPR and CESifo

  2. Active fiscal policy is regaining popularity… • Fiscal stimulation packages to revive the Japanese economy • Most recently in the U.S. • Total of 150 billion • 100 billion lump-sum transfers • 50 billion business tax cuts

  3. What are the effects? • Theoretical • Closed economy • Open economy • Empirical effects • “Internal” variables • Open economy • Own estimates for the EU • Many different potential instruments • Wide variations in findings

  4. Theory – closed economy • Standard textbook model: IS – LM • Short-run model: price level fixed • Goods market: interest rate  → investment  → output  to restore equilibrium • Money market: interest rate  → money demand  → output  to restore demand (and equilibrium) • Fiscal expansion → demand  → given interest rate, output  to restore equilibrium • Problems IS-LM • Ad hoc: no optimisation • Consequences of fiscal expansion for debt (hence, future taxes) neglected

  5. Fiscal expansion in the IS-LM model Interest rate LM-curve IS-curve Output

  6. Theory – closed economy • Neo-classical: • Government spending  → (future) taxes  (“wealth effect”)→ output , consumption  and labour supply  → real wage  and investment  • New-Keynesian (with price rigidity) • Wealth effect→ real wage  • Government spending  → goods demand → for given price, output  → labor demand  → real wage  • Overall real wage effect ambiguous • Consumption still  • Additional imperfection needed to strengthen link disposable income and consumption (e.g. credit constraint)

  7. Theory – open economy • Mundell-Fleming • Flexible exchange rate • Fiscal expansion → shifts IS out → rH > rF → capital inflow → e.r. appreciates → net exports  → IS shifts back → output unchanged • Fixed exchange rate • Fiscal expansion → shifts IS out → rH > rF → capital inflow → money supply to prevent exch rate appreciation → output higher • Same disadvantages as IS-LM

  8. Theory – open economy • Various factors are relevant: • Neo-classical vs new-Keynesian (price rigidities) • Credit restrictions / non-Ricardian consumers • Shock persistence (size of wealth effect) • Market completeness (possibilities for risk-sharing) • Small or large open economy • Home bias in spending • Elasticity of substitution domestic and foreign goods • Degree of openness of economy (amount of international trade)

  9. Empirics – “internal” effects • Blanchard & Perotti (2002) for U.S. • govt purchases  → output  (multiplier close to unity), consumption  and investment  • net taxes  → output  and investment  • Mountford & Uhlig (2005) for U.S. • govt purchases  → small positive effect on output and consumption; negative effect on investment; costly effect of higher future taxes • tax-cut best way to stimulate economy • Romer and Romer (2007): official documents to identify “exogenous” legislated tax changes • 1% of GDP rise in tax revenues → 3% fall in GDP ; 2.6% fall in consumption

  10. Empirics – open economy • Kim and Roubini (2004) for U.S.: budget deficit  → real exch rate depreciation and current account improvement • Müller (2006) find increase in net exports for U.S. • Monacelli and Perotti (2006) and Ravn et al. (2007) for Australia, Canada, U.K. and U.S.: govt purchases  → cons , output , trade balance , real exch rate depreciation • Lane and Perotti (1998, 2003): wage govt cons  → undermines competitiveness traded sector → trade balance  , especially under flex exch rates • Composition of fiscal impulse important!

  11. Own estimates for EU • Following Beetsma et al. (2008, JEEA) • Panel SVAR approach • 14 EU countries • Period 1970-2004, annual data • Estimate system with government purchases, cyclically-adjusted net taxes (tax – transfers), exports, output, imports, real effective exchange rate (fall = appreciation) • All real and in natural logarithms

  12. Impulse responses after a government purchases shock

  13. Findings • 1% of GDP increase in government purchases • Impact increase in GDP is 1.2% • Peak rise is 1.6% • Cyclically-adjusted net taxes fall • Exports rise (domestic prices rise relative to foreign) • Imports rise • Real effective exchange rate appreciates • Primary budget falls by 0.5% on impact, -0.8% peak • public budget falls by 0.7% on impact • “twin deficits”

  14. Closed versus open economies • Split based on average over time of (Exports+imports)/GDP • Closed: Finland, France, Germany, Greece, Italy, Spain, U.K. • Open: Austria, Belgium, Denmark, Ireland, The Netherlands, Portugal and Sweden • More “leakage effects” in open economies?

  15. “Closed” EU countries

  16. “Open” EU countries

  17. Findings: • Output impact closed 1.43 • Output impact open 0.83 • Normalised responses imports or exports: divide own response by response of output • Normalised import response closed vs open is 0.72 vs 0.49 • Normalised export response closed vs open is -0.41 vs -0.99 • Larger trade balance deterioration for open • Stronger and longer-lasting public budget deterioration for open

  18. Conclusions • Bulk of evidence consistent with positive effect net tax  or government purchases  on output and consumption • Output cost of future tax increase may dominate gain of government purchases rise • Strong disagreement about magnitudes of effects • Empirical analysis hampered by • Identifying truly exogenous shocks • Anticipation effects

  19. Conclusions • Active fiscal stabilization policy seems beyond capabilities of governments • Uncertainty about size (often even sign) of effects • Time lag between identification slowdown and implementation of measures • Current macroeconomic situation difficult to measure (large data revisions). • Fatas and Mihov (2003): discretionary fiscal policy induces macro-economic instability, which, in turn, affects growth negatively

  20. Conclusions • In open economies (Sweden) a substantial part of increase in government purchases leaks away • Effect of increase in government purchases unevenly distributed → export sectors in particular hurt, because competitiveness  • Best is to let automatic stabilisers work freely • However, they do not distinguish source of shock, nor whether it is temporary or permanent • Complement with automatic link between debt and taxes or cyclically adjusted primary deficit

More Related