A Modern Money Perspective on Financial Crowding-out

Abstract

The withdrawal of discretionary fiscal stimulus and a renewed emphasis on institutional and ‘self-imposed’ budgetary constraints are evidence that the imperative of fiscal sustainability and sound accounting fundamentals continue to drive fiscal policymaking within many advanced economies. To buttress the urgency for fiscal sustainability, neo-liberals often draw upon financial crowding-out theory. Despite an extensive literature, empirical applications are often misspecified due to their failure to account for different institutional arrangements. However, the policy responses of national governments to the Global Financial Crisis have highlighted the institutional disparities, presenting a unique opportunity for a rigorous empirical investigation. This paper develops panel vector error correction models for both sovereign and non-sovereign economies over the period 1999 to 2010 to examine financial crowding-out. The empirical evidence reveals crowding-out effects in non-sovereign economies, but not within sovereign economies.     

Increase in home bias in the Eurozone debt crisis: The role of domestic shocks

One of the most striking consequences of the recent episode of sovereign debt market stress in the Eurozone has been the increase in the share of public debt held by the domestic sector in fragile economies. However, the causes and potential consequences of this increase were only given scarce attention in the literature on the Euro area sovereign debt crisis. In order to fill this gap, we first determine the shocks that impact the variation in the share of sovereign debt held at home in an SVAR model on a sample of Eurozone countries between 2002 and 2014, distinguishing between external and domestic shocks. Thanks to several alternative tests, we show that home bias in sovereign debt responds positively to country-specific fundamentals and expectation shocks but we find no evidence that the increase in home bias is destabilizing per se in the short-run. Second, a stylized theoretical model backed by the empirical results predicts that the consequences for sovereign debt crisis depend on the relative impact of domestic initial destabilizing shocks and increased home bias. The analysis suggests that an increase in home bias in times of sovereign debt stress, despite reflecting deteriorating fiscal conditions, may make default less likely.     

Growth Effects of Fiscal Policy and Debt Sustainability in the EU

In this paper we study the relationship of fiscal policy and economicperformance of some core countries in the EU. Our aim is to find outwhether public deficit and public debt have consequences for real variables in the economies we consider. The background of our empirical study is a growth model that provides us with some predictions on the relationship between fiscal policy and economic growth. In a first step we then use Granger causality tests to analyze empirically whether some of the implications of our model arecompatible with the data. In a second step, we investigate whether the fiscalpolicies of the member states have been sustainable. Given this information,we then pursue the question of whether differences in the fiscal positions ofcountries have consequences as concerns the outcome of our empirical testsof step one. Finally, we study whether the impact of the public deficit ratiodepends on the magnitude of the debt ratio.     

Debt uncertainty and economic growth: evidence from five highly indebted Eurozone countries

The goal of this study is to examine the relationships between economic growth and debt uncertainty by applying the threshold generalized autoregressive conditional heteroscedasticity modelling methodology in five Eurozone countries spanning the period 2001–2013. The results document that during the European fiscal crisis period, debt uncertainty exerts a significant negative effect on economic growth across all five Eurozone countries that experienced the deterioration of their fiscal positions.     

Public debt management and credibility: Evidence from an emerging economy

This study is a contribution to the literature concerning the management of the public debt in emerging economies. A novelty in this article is the introduction of a fiscal credibility index based on the market's expectations in regard to the public debt to GDP ratio. The main objective is to present empirical evidence for the Brazilian case concerning the framework of the public debt composition and also the effect of this framework on public debt to GDP ratio. The findings demonstrate that the commitment with the public debt increases the fiscal credibility and that it is crucial for the success of the management of the public debt. Contrary to what is recommended in the standard literature an increase in the average maturity and the share of inflation-linked bonds imply costs that cannot be neglected.     

Political and economic determinants of OECD budget deficits and government expenditures: A reinvestigation

Recent theoretical and empirical research has examined the variation in political and institutional arrangements which may affect national policy formation, in order to explain cross-country differences in fiscal policies. In this note we investigate cross-country differences in debt accumulation and the level of government spending in the OECD countries over the period 1982–1992. Our findings are negative and suggest a reappraisal of previous research. In particular, neither the growth of government debt nor the level of government spending is related to the corrected Roubini–Sachs power dispersion index.     

中国地方政府债务可持续、财政空间与经济增长*

根据Ghosh et al（2013）财政空间理论，利用2010—2019中国省级面板数据，对中国省级政府债务可持续、财政空间和经济增长之间的关系及其机制进行了研究。结果表明，中国个别省份出现了财政疲劳现象，要把控好债务风险雷区，但各地区债务限额存在异质性，在不损害可持续性的情况下，大部分地方政府有足够的“回旋余地”实施财政刺激政策。我国省级政府的财政空间和经济增长之间存在倒“U”型关系，即当政府负债率高于财政空间的临界点（或较低的财政空间）时开始阻碍经济增长，因此，需要通过降低政府负债率实现更高的增长。进一步研究发现，政府债务影响经济增长最重要的渠道是公共投资和私人投资，全要素生产率、储蓄和长期真实利率也是政府债务影响经济增长的重要渠道，而长期名义利率未能成为政府债务影响经济增长的渠道。     

The effect of monetary and fiscal credibility on public debt: empirical evidence from the Brazilian economy

This study relates to the literature regarding credibility effect on public debt for developing economies under inflation targeting. The novelty is the investigation of effects of both monetary and fiscal credibility on public debt and its management. The main idea is that high credibility might improve public debt management. With this purpose, this paper addresses empirical evidence based on the Brazilian experience. The findings denote that credibility is an important instrument to improve the public debt management under inflation targeting.     

The effectiveness of fiscal spending in Croatia,Slovenia and Serbia: the role of trade openness and public debt level

Various structural characteristics of economies, directly or indirectly, affect the transmission from government stimuli to economic activity and determine the size of fiscal multipliers. In this article, we expand the standard Blanchard–Perotti fiscal SVAR model by incorporating the public debt and trade openness variables to assess the influence of these structural determinants on the effectiveness of fiscal spending in three selected former Yugoslav countries – Slovenia, Croatia and Serbia. The results confirmed the main hypotheses, which state that public debt level and trade openness significantly affect the effectiveness of fiscal spending through the means of reduction in size of fiscal effects in all countries analysed. When comparing internationally, this reduction tends to be more evident in countries with a higher degree of average public debt level and trade openness.     

Public investment,national debt,and economic growth: The role of debt finance under dynamic inefficiency

Public investment is a central issue in the dynamic analyses of fiscal policy and economic growth. Debt financing for public investment and its effects have recently received great attention because interest rates have been low, almost invariably remaining below economic growth rates. This paper presents examination of the effects of debt-financed public investment subject to a simple fiscal rule in an overlapping generations model with public capital. This topic includes capital budgeting and the debt–deficit criterion of the Maastricht treaty. We show herein that debt financing for public investment enhances economic growth if an economy is dynamically inefficient and if public capital has a sufficiently large productivity effect. Moreover, it reduces economic growth rates in a dynamically efficient economy. Debt and growth can have a monotonic or non-monotonic relation, depending on the steady-state interest rate, growth rate, and productivity effect of public investment. The findings indicate that debt–growth relations match with controversial empirical evidence. Furthermore, existing generations choose perfect debt finance if dynamic inefficiency exists. In contrast, a balanced budget is preferred in a dynamically efficient economy with low productivity effects of public capital. However, an economy with high productivity effects of public capital might cho ose debt financing. This paper contributes to the elucidation of currently emphasized issues of public investment.     

FISCAL POLICY RULES AND THE SUSTAINABILITY OF PUBLIC DEBT IN EUROPE*

The sustainability of public debt is interpreted as the result of the interaction of fiscal policy with the economic environment, and not as a statistical concept as in most of the recent literature. If debt is not to explode over time, policymakers have to respond to the changing conditions in the macroeconomic environment. This article defines the conditions that will ensure compliance of fiscal policy with the intertemporal budget constraint in the context of Europe's fiscal policy rules. The empirical part of the article reveals that European public debt is sustainable in this respect, but questions regarding long‐run liquidity requirements remain unresolved.     

Inequality and public debt: A positive analysis

This study extends the multi‐country, politico‐economic model of fiscal policy to incorporate wage inequality within each country. In this extended framework, we present conflict over fiscal policy within and across generations and show that a low‐inequality country realizes tight fiscal policy with low public debt accumulation, whereas a high‐inequality country experiences loose fiscal policy with high public debt. This model prediction is consistent with empirical evidence from OECD countries for the years 1980 to 2010.     

Sovereign Risk,Public Investment and the Fiscal Policy Stance

Of the different types of government outlays, since the 2000s public investment has been the main variable of adjustment during recessions in advanced and emerging economies. These contractions (expansions) have been associated with relatively medium-high (low) sovereign spreads, especially in advanced economies. To rationalize these issues, we develop a model of fiscal policy and sovereign default, with corporate default risk. Policymakers must decide between the provision of an unproductive public good and public investment, weighting their respective net benefits in terms of short-term stabilization and debt sustainability. In our model, investment follows a countercyclical stance only in the case of low levels of debt and moderate negative shocks, and otherwise contracts during recessions. The policy stance, along with the mix between different outlays, is determined by how sovereign risk responds to adverse economic shocks.     

Fiscal Prudence and Growth Sustainability: An Analysis of China's Public Debts

This paper analyses and assesses China's current fiscal system, including its basic institutional arrangements, the relationship between central and local governments, and the fiscal balance and public debt. This paper pays special attention to the local government borrowings that have increased dramatically in recent years, and tries to measure the “overall public debt risk” by including all kinds of eligible debts. This paper finds that although the large expansion of local government debt during the fiscal stimulation response to the global financial crisis was devastating, the all‐inclusive total public debt to gross domestic product ratio remains under 50%, and as long as the local debt stops growing, the risk is quite manageable. This paper also points out that more attention should be paid to improving and reforming the Chinese fiscal system, particularly the reform of the fiscal relationship between central and local governments, and the legal framework for local government debt management.     

Inflation and Exchange Rate Targeting Challenges Under Fiscal Dominance

Countries have significantly increased their public-sector borrowing since the Global Financial Crisis. As a consequence, monetary authorities may face pressure to deviate from their policy targets in ways designed to ease the debt burden. In view of this consideration, we test for greater fiscal dominance over 2000-2017 under Inflation Targeting (IT) and non-IT regimes. We find that evidence of fiscal dominance varies across countries and debt configurations. Higher ratios of public debt-to-GDP may appear associated with lower policy interest rates in advanced economies. However, a declining natural rate of interest largely explains the pattern of lower rates and higher debt in these countries. The most robust evidence of fiscal dominance lies among emerging markets under non-IT regimes, composed mostly of exchange rate targeters. For these countries, policy interest rates are non-linearly associated with public debt levels, depending on both the level of hard-currency public debt-to-GDP and the currency composition of public debt. We also show that emerging market economies with greater exchange rate volatility, inflation volatility, and underlying commodity exposure exhibit stronger associations between public debt and policy interest rates.     

Debt,seigniorage, and the Growth Laffer Curve in developing countries

The endogenous growth literature established the existence of an inverted-U curve between taxes and economic growth, namely a Growth Laffer Curve, but empirical evidence on this relationship in developing countries is rather limited. Given that seigniorage and public debt are also important means of financing public spending in these countries, we take into account in this paper their respective impacts on growth, as they might deform the existing relationship between taxes and growth. To this end, we develop a growth model with public investment as the engine of perpetual growth, and look for the effect of debt, tax and money financing on economic growth. We study in particular the way fiscal and monetary policies deform the Growth Laffer Curve in developing countries. An empirical section based on a panel of 100 developing countries over the period 1980–2010 provides both OLS-Fixed Effects and GMM-system estimations that support our theoretical conclusions, namely the existence of Growth Laffer Curves indexed by the levels of debt and of seigniorage.     

Financial development,institutional quality and maximizing-growth trade-off in government finance

This paper studies monetary and fiscal policies in an endogenous growth model with transaction costs. We show that the relation between long-run economic growth and both monetary and fiscal policies is subject to threshold effects, a result that gives account of a number of recent empirical findings. Furthermore, the model shows that, to finance public expenditures, growth-maximizing governments must choose relatively high seigniorage (respectively income taxation), if “institutional quality” and “financial development” indicators are low (respectively high). Thus, our model may explain why some governments resort to seigniorage and inflationary finance, and others rather resort to high tax rates, as a result of growth-maximizing strategies in different structural environments (notably concerning institutional and financial development contexts). In addition, the model allows examining how the optimal mix of government finance changes in response to different public debt contexts. A short empirical section confirms our theoretical results.     

Cross-country fiscal policy spillovers and capital-skill complementarity in integrated capital markets

The 2010 European sovereign debt crisis has renewed discussions on fiscal policy coordination. One rationale for coordination is fiscal policy cross-country spillovers. A common finding in the literature is that spillovers tend to be small in normal circumstances but can be large if monetary policy is at the zero lower bound. Orthogonal to the existing literature, we document a novel channel that generates cross-country spillovers over the medium run. We assume perfect capital markets integration and find that capital-skill complementarity can lead to large spillovers without the zero lower bound nor a large import share in government expenditures. As capital markets have become increasingly integrated in the Eurozone, the current degree of fiscal policy coordination between its members, low, may be insufficient. We also find that the smoothing benefits from a temporary rise in public debt spill over to other countries.     

Fiscal transparency, political parties, and debt in OECD countries

Many believe and argue that fiscal, or budgetary, transparency has large, positive effects on fiscal performance. However, the evidence linking transparency and fiscal policy outcomes is less compelling. To analyze the effects of fiscal transparency on public debt accumulation, we present a career-concerns model with political parties. This allows us to integrate as implications of a single model three hitherto-separate results in the literature on deficit and debt accumulation: that transparency decreases debt accumulation (at least by reducing an electoral cycle in deficits), that right-wing governments (at least for strategic reasons) tend to have higher deficits than left-wing governments, and that increasing political polarization increases debt accumulation. To test the predictions of the model, we construct a replicable index of fiscal transparency on 19-country OECD data. Simultaneous estimates of debt and transparency strongly confirm that a higher degree of fiscal transparency is associated with lower public debt and deficits, independent of controls for explanatory variables from other approaches.     

Mispricing of Risk in Sovereign Bond Markets with Asymmetric Information

The likelihood that a government will repay its sovereign debt depends both on the amount of debt it issues and on the government's future ability to repay. Whilst the former is publicly observable, the government may have more information about the latter than investors. This paper shows that this asymmetric information problem impairs the market's ability to differentiate economies according to their fiscal sustainability, and can lead to a disconnect between bond prices and default risk. The model can help rationalise the behaviour of Eurozone bond prices prior to the recent European sovereign debt crisis.