The effectiveness of fiscal policy in a keynesian-monetarist model of Canada

This paper presents a simple macroeconomic model that includes all of the main channels of transmission for fiscal policy and that can generate either Keynesian or monetarist results for the impact of fiscal policy depending on the values assumed for particular parameters. The structure of this model, called KEMO for KEynesian-MOnetarist, was kept very simple and schematic. The objective of this paper is to examine through simulations of the model the degree of sensitivity of the fiscal multiplier to certain hypotheses concerning the way the economy functions and the value of certain parameters, as well as the dynamic process of adjustment of the economy to a fiscal shock.     

Capital mobility and the effectiveness of fiscal policy in open economies

This paper uses a dynamic general equilibrium two-country optimizing ‘new-open economy macroeconomics’ model to analyze the consequences of international capital mobility for the effectiveness of fiscal policy. Conventional wisdom suggests that higher capital mobility diminishes the effectiveness of fiscal policy. The model laid out in this paper provides an example that a higher degree of capital mobility can also increase the effectiveness of fiscal policy. This tends to be the case if the stance of monetary policy can be described by means of a simple monetary policy rule.     

The effectiveness of fiscal and monetary policy responses to twin crises

We study how effective fiscal and monetary policy responses are during a twin crisis. Using the dataset provided by Laeven and Valencia (2008 Laeven, L and Valencia, F. (2008) Systemic banking crises: a new database. IMF Working Paper No. 08/224 [Google Scholar]), we identify 57 episodes of twin crises. Following the methods proposed in Baldacci et al. (2009 Baldacci, E. 2009. Gupta, S. and Mulas-Granados, C., How effective is fiscal policy response in systemic banking crises?, IMF Working Paper No. 09/160 [Google Scholar]) and Hutchison et al. (2010 Hutchison, M. 2010. Noy, I. and Wang, L., Fiscal and monetary policies and the cost of sudden stops, Journal of International Money and Finance, 29, 973–87 [Google Scholar]), we construct the variables measuring the duration and output cost of a twin crisis. We find that fiscal policy does not seem to be associated with the shortening of a twin crisis. Regarding monetary policy, we find that monetary tightening is associated with the lengthening of a twin crisis duration, consistent with the result in Hutchison et al. (2010 Hutchison, M. 2010. Noy, I. and Wang, L., Fiscal and monetary policies and the cost of sudden stops, Journal of International Money and Finance, 29, 973–87 [Google Scholar]) dealing with a sudden stop crisis. In addition, our results show that while a mild monetary expansion is effective in reducing a twin crisis duration, over-expansionary monetary policy loses its effectiveness.     

‘Crowding out’ and the effectiveness of fiscal policy

‘Crowding out’ of private economic activity by public economic activity is a multidimensional concept. A taxonomy is proposed: the degree of crowding out, the time horizon considered, direct and indirect crowding out constitute the four main categories. The latter two each have many subcategories. With direct crowding out government economic activity directly enters as an agrument into structural private behavioural relationships. Indirect crowding out refers to crowding out in the reduced form of the model without there being any direct crowding out at the level of the structural private behavioural relationships. A small full employment model is used to analyse the implications of various forms of direct crowding out for the effectiveness of fiscal policy.     

Trade openness and the effectiveness of fiscal policy: some empirical evidence

Is the potency of fiscal policy lower for more open economies, as suggested by economic theory? Using annual data from the period 1951?C2007, for 62 developed and developing economies, the paper??s empirical findings show that the effectiveness of fiscal policy is indeed reduced by an economy??s trade openness, and that the effect is quantitatively substantial. In particular, the paper??s estimates suggest that an increase in trade openness by 10% of GDP reduces the magnitude of the long-run fiscal multiplier by 5?C6%.     

The importance of composition of fiscal policy: evidence from different exchange rate regimes

We study the macroeconomic effects of fiscal policies in an open economy. We emphasize two transmission mechanisms: the cost channel, by which wage government spending and labor taxes raise the real wage firms must pay, and the exchange rate channel, by which the nominal exchange rate shifts induced by fiscal policy have real effects if (some) prices and wages are sticky. The latter channel implies that changes in wage government spending or in labor taxation should have different effects under flexible than under fixed exchange rates. In a 1964–93 panel of OECD countries we find significant evidence for both channels. Moreover, we find that the real product wage and profitability are more responsive than quantities (employment and output) to fiscal policy innovations.     

The effect of fiscal system reform on fiscal policy outcomes

We investigate how reform in governmental accounting affects fiscal policy outcomes including debt, balance, and fiscal transparency. Since a change from cash to accrual accounting can be regarded as a natural experiment among governments, a fixed-effects model is exploited. We discover that the change diminishes debt in developed countries, but expands it in less-developed ones, with strong effects in highly indebted countries. The change improves balance in developed countries and worsens it in less-developed countries, which is significant for developed countries with large deficits. Transparency is improved only in less transparent developed countries.     

The macroeconomic effects of fiscal policy

We investigate the macroeconomic effects of fiscal policy using a Bayesian Structural Vector Autoregression (B-SVAR) approach. We identify fiscal policy shocks via a partial identification scheme, but also: (i) include the feedback from government debt; (ii) look at the impact on the composition of output; (iii) assess the effects on asset markets; (iv) use quarterly data; and (v) analyse empirical evidence from the US, the UK, Germany and Italy. The results show that government spending shocks, in general, have a small effect on Gross Domestic Product (GDP); lead to important ‘crowding-out’ effects; have a varied impact on housing prices and generate a quick fall in stock prices. Government revenue shocks generate a mixed effect on housing prices and a small and positive effect on stock prices. The empirical evidence also suggests that it is important to explicitly consider the government debt dynamics in the model.     

The impact of national fiscal rules on the stabilisation function of fiscal policy

We study the relationship between discretionary fiscal policy and macroeconomic stability in 21 OECD countries over the 1985–2012 period. The novelties of our contribution lie in the use of annual panel data, whereas most of the existing evidence is cross-sectional, and more importantly in the thorough investigation of how fiscal rules affect the policy-macroeconomic stability relationship. We find that the aggressive use of discretionary fiscal policy, particularly of government consumption items, leads to higher volatility of output and, to a lesser extent, inflation. However, when strict fiscal rules are introduced, discretionary policy becomes output-stabilising rather than destabilising. This result can be more easily achieved by rules on balanced budgets, rather than on expenditures, revenues, or debt. On the other hand, fiscal rules are unable to affect the inflation-destabilising nature of discretionary policy, if any, probably because of the higher importance of central banks in that respect.     

A tool for fiscal policy planning in a medium-term fiscal framework: The FMM-MTFF model

This paper describes the FMM-MTFF model, a dynamic stochastic general equilibrium model developed to support the implementation of a Medium-Term Fiscal Framework (MTFF) in emerging market and developing economies. The model exhibits the following features. First, fiscal policy is defined in terms of multi-year fiscal plans, instead of restricting attention to univariate, single-period fiscal shocks. Second, the model temporarily deactivates the fiscal rule to avoid forcing fiscal policy to be mechanically countercyclical and sustainable. Third, the model is calibrated to match a three-sector, stylized version of a country’s input-output table, and finally, the model uses a chain-weighted procedure to measure GDP, a method consistent with what national account compilers do. The model is calibrated to Colombian and Peruvian data to illustrate the use of the model as a tool to quantify the scale of the fiscal challenges, to provide consistent medium-term macro fiscal projections and to assess the quantitative implications of past reforms and alternative fiscal policy plans on the economies, i.e., the typical questions of interest to an MTFF.     

The macroeconomic effects of fiscal policy in Spain

This paper focuses on the effects of fiscal policy in Spain analysed in a VAR context. Fiscal shocks are found to involve significant effects on GDP, private consumption, private investment, interest rates and prices. Non-Keynesian effects are observed. Moreover, evidence on the channels highlighted in the literature for such effects to arise is found, notably the effects of permanent income on consumption and investment on the demand side, coupled with the response of the equilibrium wage on the supply side affecting entrepreneurial profits and investment. The response of interest rates seems to reinforce both effects. Furthermore, the different readings of spending or taxes do not affect macroeconomic variables homogeneously.     

The fiscal outlook in Austria: an evaluation with Generational Accounts

During the next few decades the populations of most developed countries will grow older and older as a result of the low fertility rates since the 1970s and/or the continuously increasing life expectancy. Generational Accounting which was introduced in the early 1990s, can illustrate the effects of this ageing process on a country’s fiscal situation and on the intergenerational redistribution. Austria’s age dependency ratio will more than double over the next four decades in most official projections. In our paper we quantify for Austria how unsustainable its public finances are due to the demographic development. We show that despite recent reforms of the pension and health systems the demographic development produces a major problem for Austria’s coffers. Furthermore we compare our results to similar calculations for Germany and Switzerland.     

Entry and fiscal policy effectiveness in a small open economy within a Monetary Union

In this article I develop an imperfectly competitive dynamic general equilibrium model for a small open economy integrated in a monetary union. Here, the type of entry in the non-traded goods’ sector affects fiscal policy effectiveness. Fiscal policy effectiveness is enlarged when aggregate demand stimuli increase intra-industrial competition (case I). This is due to the counter-cyclical mark-up mechanism generated by entry. Such a mechanism is absent in the usual monopolistic competition where entry only has a sharing effect (case II).

On the neutrality of fiscal policy

The paper explores the relationships between fiscal policy and real economic activity and prices for the six largest industrialized economies. Fiscal policy variables are shown to be consistent and rational functions of the behaviour of the economy. It is also confirmed that fiscal policy seems to have a consistent impact on subsequent real economic activity and prices. When multivariate time series analysis is used to breakdown overall fiscal policy into anticipated and unanticipated components, the anticipated components are shown generally to have just as much forecasting ability for subsequently realized economic variables as the unanticipated components. This does not appear to be consistent with the implications of pure rational expectations models.     

The effectiveness of anti-leakage policies in the European Union: results for Austria

With the third trading period of the EU emissions trading scheme (EU ETS) starting in 2013, the system of allocating emission allowances will significantly change: In contrast to the previous two trading periods, auctioning of the allowances should now be the rule rather than the exception. Accompanying this policy change, concerns over competitiveness of energy intensive, trade exposed sectors as well as over limited environmental effectiveness via the channel of carbon leakage, have regained prominence. In this paper, we thus explore the impacts of potential EU policies to counter losses in international competitiveness and carbon leakage from the perspective of Austria. Based on numerical simulations with a computable general equilibrium model, we evaluate three policy options: an input subsidy for carbon allowances (thus reflecting the planned partially free allocation mechanism in the third EU ETS phase), a subsidy for domestic production, and an export rebate based on sectoral CO₂ costs. Our results show that each policy has the potential to support domestic production in exposed sectors relative to a full auctioning scenario and thus increase competitiveness. However, none is imperatively effective at reducing Austria’s net carbon emissions: while the carbon trade balance is improved and hence leakage declines, the tradability of emission permits within the EU ETS allows CO₂ emissions from Austria’s ETS output to increase. A cost benefit analysis indicates that the two policies promoting domestic output and exports are more cost effective than the CO₂ input subsidy.     

The role of fiscal policy in Britain's Great Inflation

We investigate whether the Fiscal Theory of the Price Level (FTPL) can explain UK inflation in the 1970s. We confront the identification problem involved by setting up the FTPL as a structural model for the episode and pitting it against an alternative Orthodox model; the models have a reduced form that is common in form but, because each model is over-identified, numerically distinct. We use indirect inference to test which model could be generating the VECM approximation to the reduced form that we estimate on the data for the episode. Neither model is rejected, though the FTPL model substantially outperforms the Orthodox. But by far the best account of the period assumes that expectations were a probability-weighted combination of the two regimes. Fiscal policy has a substantial role in this weighted model in determining inflation. A similar model accounts for the 1980s but this role of fiscal policy is much diminished.     

The effects of fiscal policy in a two-period model

The paper analyzes fiscal policy in a model which differs from the conventional analyses in the following ways: 1) It is based on the intertemporal maximizing behavior of individual agents. 2) The government is assumed to actively balance its budget the long run. 3) Government expenditure is on useful goods and services. The welfare effects of fiscal policy are also examined. The principal conclusions are that fiscal policy is effective in the short run but the effects on both output and welfare may be perverse; and, that with full employment in the long run, fiscal policy still has allocative effects and so influences welfare.     

Cross-country evidence on determinants of fiscal policy effectiveness: the role of trade and capital flows

This article studies the determinants of size differentials between fiscal multipliers in countries around the world, both advanced and developing economies. We introduce variables not considered before for explaining multiplier size differentials, such as capital flows and the openness of capital markets, while controlling for domestic conditions and exchange rate regimes. We also disaggregate GDP into its main components in order to identify the channels through which external and internal factors can influence GDP after a change in fiscal policy. Our results point to the existence of a new channel through which fiscal policy effectiveness is affected. Capital flows, especially FDI flows, play an important role in determining the sizes of fiscal multipliers, and a country’s external conditions largely explain GDP changes after fiscal expenditure shocks. Our results also point towards a strong link between a country’s international position and its real economy.