THE ECONOMICS OF THE GOVERNMENT BUDGET CONSTRAINT

This article summarizes the simple analytics of the macroeconomiceffects of government budget deficits. The presentation is organizedaround three key relationships: the national income accountsbudget deficit identity, the deficit financing identity, andthe dynamic equation for the evolution of the ratio of publicdebt to gross national product. The national income accountsidentity highlights the effect of the deficit on domestic savingand investment and the current account. Examining the financingof the deficit brings to light the different kinds of macroeconomicimbalance the deficit can cause—as a first approximation,printing money excessively shows up as inflation, excessiveuse of foreign reserves leads to crises in the balance of payments,high foreign borrowing leads to a debt crisis, and too muchdomestic borrowing leads to high real interest rates and crowdingout of private investment. The debt dynamics equation is usedto show the long-run constraints on fiscal policy.      

FISCAL DEFICITS AND MACROECONOMIC PERFORMANCE IN DEVELOPING COUNTRIES

Although fiscal adjustment was urged on developing countriesduring the 1980s to lead them out of economic malaise, considerableuncertainty remains about the relations between fiscal policyand macroeconomic performance. To illustrate how financial markets,private spending, and the external sector react to fiscal policies,the behavior of holdings of money and public debt, private consumptionand investment, the trade balance, and the real exchange rateis modeled for a sample of ten developing countries. The studiesfind strong evidence that over the medium term, money financingof the deficit leads to higher inflation, while debt financingleads to higher real interest rates or increased repressionof financial markets, with the fiscal gains coming at increasinglyunfavorable terms. Consumers respond differently to conventionaltaxes, unconventional taxes (through inflation or interest andcredit controls), and debt financing, in ways that make fiscaladjustment the most effective means of increasing national saving.Private investment—but not private consumption—issensitive to the real interest rate, which rises under domesticborrowing to finance the deficit. Contrary to the popular presumption,in some countries private investment increases when public investmentdecreases. There is strong evidence that fiscal deficits spillover into external deficits, leading to appreciation of thereal exchange rate. Fiscal deficits and growth are self-reinforcing:good fiscal management preserves access to foreign lending andavoids the crowding out of private investment, while growthstabilizes the budget and improves the fiscal position. Thevirtuous circle of growth and good fiscal management is oneof the strongest arguments for a policy of low and stable fiscaldeficits.      

WHEN DO HETERODOX STABILIZATION PROGRAMS WORK?: Lessons from Experience

What advantages and disadvantages does the heterodox strategyoffer to stabilization programs in countries with chronic highinflation? Heterodox stabilization programs, in our definition,are those that support orthodox policies— that is, tightfiscal policy and a fixed exchange rate—with the initial,temporary use of incomes policies— that is, price andwage controls. This evaluation, based on several heterodox programs,successful and unsuccessful, from the 1960s and 1980s in LatinAmerican countries and Israel, affords four principal lessons: * The rapid reduction in inflation at the beginning of heterodoxprograms (which usually comes about at small cost) is the easypart; the problem is to maintain price stability over time. * Incomes policies in heterodox stabilization programs are justifiedonly in countries with high chronic inflation, where persistentinflation is more pervasive and problematic. * There is a case for a bigger fiscal adjustment in heterodoxthan in orthodox programs because of the risk that a programwith price controls may be misperceived as a populist devicefor achieving price stability without adjusting. * The failure of a heterodox program is more likely to destabilizeinflation than is the failure of an orthodox program.      

Walking up the Down Escalator: Public Investment and Fiscal Stability

When growth-promoting spending is cut so much that the presentvalue of future government revenues falls by more than the immediateimprovement in the cash deficit, fiscal adjustment becomes likewalking up the down escalator. Although short-term cash flowsmatter, too tight a focus on them encourages governments toinvest too little. Cash-flow targets also encourage governmentsto shift investment spending off budget by seeking private investmentin public projects, irrespective of its real fiscal or economicbenefits. To deal with this problem, some observers have suggestedexcluding certain investments (such as those undertaken by publicenterprises deemed commercial or financed by multilaterals)from cash-flow targets. These stopgap remedies may help protectsome investments, but they do not provide a satisfactory solutionto the underlying problem. Governments can more effectivelyreduce the biases created by the focus on short-term cash flowsby developing indicators of the long-term fiscal effects oftheir decisions, including accounting and economic measuresof net worth, and, where appropriate, including such measuresin fiscal targets or even fiscal rules. JEL codes: O23, E62, H60, H54     

INDEXATION AND STABILIZATION: Theory and Experience

This article describes early models of indexing as well as morerecent models that call for less indexing of wages to pricesin order to improve price and output stability. Policymakersmay face a tradeoff: although increasing indexation may leadto macro-economic instability, reducing indexation may leadto greater income inequality and labor market tension. The article then concentrates on recent experiences, first incountries that have long histories of indexing (Brazil and Israel),then in countries that have reduced indexing (Chile, Finland,and Iceland) or that have used indexing under moderate inflation(Australia and Italy). Where disindexation worked, the costsof stabilization (involving both disindexation and fiscal correction)were recognized, and political agreements permitted an acceptabledistribution of these costs.      

STABILIZATION POLICIES IN DEVELOPING COUNTRIES

The article focuses on the design of stabilization measuresto correct excessive balance of payments deficits and moderatethe rate of inflation. It distinguishes three sources of balanceof payments difficulties—excessively expansionary aggregatedemand policies; domestic supply shocks stemming, for example,from increases in real wages in excess of productivity growth;and external terms of trade shocks. It also analyzes the effectsof devaluations. The second part of the article discusses policiesaimed at reducing the rate of inflation and summarizes the theoreticalliterature on the dynamics and the transitional costs of adjustmentto lower rates of inflation in closed economies. Evidence onthe adjustment costs of disinflationary policies is reviewed,and the discussion is extended to some recent analysis of adjustmentin open economies.      

Inflation Triggers in Transition Economies: Their Evolution and Specific Features

Analysis of thirty inflation episodes in sixteen European transition economies, using the probit panel model with fixed effects, uncovers inflation triggers that overlap with those obtained in either developing or developed countries or both. However, we found some transition-specific features. Thus, the relative contribution of the triggers evolves as transition progresses, such that the early dominance of the output gap, the fiscal deficit, and elections are subsequently subdued by a rise in food and oil prices, the exchange rate regime, and the current account deficit. The last two triggers could be linked to deep financial integration in Europe and the consequent large flow of capital toward European transition economies in the 2000s, a phenomenon not observed in any other part of the world. In addition, the exchange rate regime as an inflation starter in transitional Europe may be due to its convergence with developed Europe and the resulting real appreciation of currency.     

The Political Economy of Economic Liberalization

Two of the major policy problems facing governments of developingcountries in the 1980s have been unsustainable external andinternal disequilibria, and implementation of politically feasiblestabilization cum liberalization programs which become necessaryto correct these imbalances. This article discusses these "crises"and subsequent policy reform. The analysis suggests that balanceof payments and fiscal deficits are frequently the result ofuse of an incorrect accounting system in a fixed exchange rateeconomy, and of public sector expansion beyond its economicallyfeasible size; that governments usually seek to liberalize theireconomies during a crisis to regain control when the growthof the "transfer State" has led to generalized tax resistance,avoidance, or evasion; that reduction of the government rolewill be required to alleviate these crises; that sharp departuresfrom past policies rather than gradual reform may be politicallynecessary; and that, contrary to the current technocratic opinionon this matter, the sequencing of a consistent and crediblepackage of reforms which will most effectively reduce the costsof adjustment is initial liberalization of domestic capitalmarkets simultaneous with cuts in the fiscal deficit, followedby floating the exchange rate and then commodity market liberalization.     

MACROECONOMIC ADJUSTMENT IN DEVELOPING COUNTRIES: A POLICY PERSPECTIVE

A comprehensive macroeconomic adjustment program is expectedto have the following objectives: a sustainable current accountposition, a stable and high rate of economic growth that wouldallow for a steady rise in per capita consumption, a reducedrate of inflation, and a manageable level of foreign debt. Thepackage designed to meet these objectives would typically includepolicy measures that simultatenously restrain aggregate demandand increase the availability of resources. These policies maybe grouped as follows: demand-management policies, structuralpolicies, exchange rate policies, and external financing policies.This article describes how these policies can be expected toachieve the goal of macroeconomic adjustment. The focus is primarilyon the theoretical and empirical links between policy instrumentsand ultimate objectives. An examination of these links is necessarybefore issues of the appropriate mix of demand-management, structural,exchange rate, and external policies, and the sequencing ofthese policies in a program, can be properly addressed.      

External Debt, Inflation, and the Public Sector: Toward Fiscal Policy for Sustainable Growth

Which tradeoffs are involved in formulating an external debtstrategy? Should expenditure be cut to improve the current account,or will this reduce future output growth, thus undermining thebenefits of any debt reduction? Are there alternatives thatallow satisfactory output growth without jeopardizing creditworthiness?How can the necessary surplus of savings over investment bebrought about at levels of investment high enough to sustainoutput growth? Should the government contribute to the internal adjustmentby reducing its deficit? Macroeconomic targets for inflationand growth, and creditworthiness constraints on debt issue,impose restrictions on the extent to which deficits can be financed.Can the government cover the deficit within these targets andconstraints? The absence of such consistency forebodes futurepolicy change and so undermines the credibility of the adjustmentprogram. The author uses empirical work on Turkey to illustratethe interactions between fiscal deficits and the macroeconomicvariables upon which fiscal consistency hinges.     

Lessons from Experiences with High Inflation

In economies where price control has been the rule, the mostserious concern may be recognition of the inflation problem.Beyond the initial correction of subsidies there is the broaderissue of the risk of a serious inflation. This article looksat the problem of high inflation in developing countries inEurope and Latin America and draws lessons from historical experience.It analyzes the dynamics of the interaction among deficit finance,institutional innovation in financial markets, dollarization,and the shortening of wage contracts in high-inflation situations.When stabilization is undertaken, there is neither immediate,spontaneous resumption of longer adjustment periods for wagesand prices nor instant increase of real money demand to noninflationarylevels. Incomes policy—freezing exchange rates, wages,and prices—is advocated as an effective supplement tothe inevitable budget cut to make up for institutional inertiaand facilitate the start of the stabilization process.     

The Strange and Futile World of Trade Wars

U.S. President Donald Trump has a misguided, mercantilist view of international trade. He believes that an external (or “trade”) deficit is a “problem,” and that this deficit is caused by foreigners engaging in unfair trade practices. Accordingly, the president and his followers feel that the U.S. is being—and has long been—victimized by foreigners. The reality, however, is that the negative external balance in the U.S. is neither a “problem” nor is it attributable to foreigners engaging in nefarious activities. The U.S.'s negative external balance, which the country has registered every year since 1975, is “made in the USA.” External balances are always and everywhere homegrown; they are the reflection and the result of the relationship between domestic savings and domestic investment. And it is the gap between a country's savings and domestic investment that is the fundamental driver and determinant of its external balance. Specifically, the current account balance, or “trade deficit,” is the sum of the private savings‐investment gap and the public savings‐investment gap, or what is known as the “fiscal balance.” From 1972 until the end of 2018, for example, the cumulative private sector savings‐investment gap in the U.S. was a positive $12.8 trillion; that is, U.S. companies and individuals collectively saved—that is, earned and retained—some $12.8 trillion more than they consumed and invested domestically. But this positive balance was completely overshadowed by the cumulative negative government gap—or cumulative fiscal deficits—of $24.2 trillion during this 47‐year period. And thus the U.S. as a whole experienced a savings‐investment gap of negative $11.4 trillion that is entirely attributable to the country's fiscal deficits. What's more, the fact that the U.S. recorded a cumulative current account deficit of $11.5 trillion during this period confirms that the U.S. external deficits simply mirror what is happening in the U.S. domestic economy, just as the savings‐investment identity suggests. And, of course, the savings‐investment identity holds true for all countries, even those with significant external surpluses. Japan and China have both long experienced savings surpluses, and both have run current account surpluses that have mirrored their positive savings‐investment gaps. If the U.S. mercantilists understood what causes trade and current account deficits, they would direct their ire at profligate government spending rather than at foreigners. But they don't understand. And the leader of the mercantilists, President Trump, is flying blind and presiding over ever‐expanding fiscal deficits—which will only ensure that the current account deficits not just continue, but get bigger.     

Current account adjustment in industrial countries

This paper examines the dynamics of current account adjustment among industrial countries. The purpose is to evaluate whether there is a threshold level of a current account deficit at which it becomes unsustainable and whether it is possible to characterize episodes of adjustment. We identify 25 episodes in which there was a sustained improvement in the current account following a large deficit between 1980 and 1997. We find that a typical current account reversal begins when the current account deficit is about 5% of GDP. However, we also find considerable cross-country variation in the reversal threshold, consistent with a stock-adjustment model of current account sustainability. Reversals are associated with slowing income growth and a 10–20% real exchange rate depreciation. Real export growth, declining investment, and an eventual leveling off in the budget deficit–GDP ratio are also likely to be part of the adjustment. These results imply that current account reversals in industrialized countries are related to the business cycle.     

Inflation and the Financing of Government Expenditure: an Introductory Analysis with an Application to Turkey

This article presents a simple framework to assess the consistencyof appropriately defined fiscal deficits with other macroeconomictargets, such as inflation. It also considers the relation offiscal deficits to output growth, real exchange rate developments,and management of internal and external debt. Finally, it considersthe implications of relying on interest-bearing government debtto postpone the adjustment necessary to restore consistencywith inflation targets. It demonstrates how the intertemporalbudget constraint of the government creates a tradeoff betweencurrent and future adjustment. Real interest rates and outputgrowth rates are shown to determine the terms at which thistradeoff takes place. The usefulness of this framework is demonstratedthrough an analysis of fiscal policy options in Turkey in 1985.     

A Structural VAR (SVAR) analysis of fiscal shocks on current accounts in India

The stimulus packages announced to deal with the economic slowdown has increased the fiscal deficit of many countries and it spurred the debate on the possible effect of these fiscal shocks on other economic variable especially the current account. In this study, we examine the effect of fiscal deficit on current account of India using the VAR as well as the Structural VAR (SVAR) analysis. Our analysis indicates that the fiscal deficit is positively affecting the current account deficit in India, as predicted by the twin deficit hypothesis. Therefore, the historical data indicates the presence of the twin deficits phenomenon in Indian context.     

财政限制下政府债务与通货膨胀研究

随着人口老龄化,许多发达经济体都步入了财政压力时代,政府对养老金的承诺大大高于财政收入,政府为了实现承诺将利用发行新债务进行融资,这将带来未来的高税收预期.随着债务水平和税率水平的上升,人们对税收的容忍度将下降,从而触碰财政限制的可能性增大.在采取固定税率情况下,调整税收不再能稳定债务,必须采取政策转变来应对.在财政限制之前债务增长与政策调节如何相互作用,若采用货币政策的被动调节来满足稳定债务,那么政府债务将影响到通货膨胀,从而使货币政策失去对通货膨胀的控制,进而需要通过财政政策来解决通胀问题.     

财政政策与经常项目赤字关系研究

经常项目赤字是货币危机或金融危机的主要原因之一。财政政策作为政府调控经常的一个重要政策工具，对经常项目有显著影响。本文从理论和实践上对财政政策与经常项目赤字之间的关系进行了深入研究。并且分析了当前我国所执行的扩张性的财政政策对我国经常项目的平衡可能产生的不利影响。最后对改善我国经常项目提出了一些财政对策。     

MACROECONOMIC ADJUSTMENT TO CAPITAL INFLOWS: LESSONS FROM RECENT LATIN AMERICAN AND EAST ASIAN EXPERIENCE

Capital inflows to some developing countries have increasedsharply in recent years. Impelled by better economic prospectsin those countries, lower international interest rates, anda slowdown of economic activity in the capital-exporting countries,the inflows have furnished financing much needed to increasethe use of existing capacity and to stimulate investment. Butcapital inflows can bring with them their own problems. Typicalmacroeconomic repercussions have been appreciation of the realexchange rate, expansion of nontradables at the expense of tradables,larger trade deficits, and, in regimes with a fixed exchangerate, higher inflation and an accumulation of foreign reserves. Should government intervene to limit some of these side effects—andif so, how? The question is especially pressing in the wakeof the Mexican crisis of December 1994. This article looks foranswers in the experience of four Latin American and five EastAsian countries between 1986 and 1993, examining the effectsof the capital inflows on the economy and comparing the differentways in which these countries responded to the problem of "toomuch" capital.      

Public sector layoffs, severance pay, and inflation in the small open economy

Because severance pay is worth 2–5 years of wages in many LDCs, public sector layoffs increase the fiscal deficit in the short run. Nevertheless, generous severance pay is not as serious a macroeconomic problem as generally thought. In the case where the fiscal deficit is financed by printing money, inflation is continuously lower under plausible conditions. When the government can borrow in world capital markets and layoffs reduce the present-value wage bill, there exists a sequence of bond sales and subsequent redemptions that guarantees continuously lower inflation. This result does not hold, however, if the reform lacks credibility.     

From Prices to Incomes: Agricultural Subsidization without Protection?

Drawing from the experience of the direct income support programsrecently introduced in the European Union, Mexico, and the UnitedStates, this article highlights problems that may arise whenthe agricultural sector of a developing economy moves from price-basedsubsidization to less distorted income support. Such programsare a step in the right direction, but as currently implemented,they have many shortcomings. Moreover, developing countriesmay lack the necessary supporting arrangements needed to makesuch programs effective. The article argues that the programsshould not restrict the use of land, that the programs shouldlast for a stipulated period of time, and that the fiscal costsshould be contained by linking income support payments to worldprices.