Monetary versus fiscal policy in India: an SVAR analysis

Conventionally, the policymakers relied on three policy alternatives to manage business cycles – debt-financed government spending, debt-financed tax rebate and interest rate. While the first two are fiscal policy instruments, the latter is a monetary policy instrument. This paper aims to capture interactions among Indian monetary and fiscal policy actions, and the impact of such policy actions on select macroeconomic variables for the period 1990Q1–2011Q4. The policy actions are identified using the sign restrictions approach combined with magnitude restrictions in a Structural Vector Autoregression framework, and interpreted using impulse responses and variance decomposition. The results show that Indian monetary policy responds to tax rebate shocks and spending shocks differently. In the case of a tax rebate shock, Indian monetary policy responds by reducing interest rates thereby accommodating fiscal expansion. On the opposite, monetary policy seems not to accommodate expenditure shocks. Interestingly, the monetary policy shock is accompanied by a fiscal expansion that threatens the credibility of the central bank actions, thus indicating fiscal policy dominance. A comparison of the efficacy of the policies suggests that the interest rate is more effective in stimulating output. Out of the two fiscal policy instruments analysed, the tax rebate seems to be the better option for stimulating output considering the output-debt trade-off.     

Fiscal Stimulus in Times of High Debt: Reconsidering Multipliers and Twin Deficits

We investigate the impact of fiscal stimuli at different levels of the government debt‐to‐GDP ratio for a sample of 17 European countries from 1970 to 2010. This is implemented in an interacted panel VAR framework in which all coefficient parameters are allowed to change continuously with the debt‐to‐GDP ratio. We find that responses to government spending shocks exhibit strong nonlinear behavior. While the overall cumulative effect of a spending shock on real GDP is positive and significant at moderate debt‐to‐GDP ratios, this effect turns negative as the ratio increases. The total cumulative effect on the trade balance as a share of GDP is negative at first but switches sign at higher levels of debt. Consequently, depending on the degree of public indebtedness, our results accommodate long‐run fiscal multipliers that are greater and smaller than one or even negative as well as twin deficit and twin divergence behavior within one sample and time period. From a policy perspective, these results lend additional support to increased prudence at high public debt ratios because the effectiveness of fiscal stimuli to boost economic activity or resolve external imbalances may not be guaranteed.     

Heterogeneous Consumers and Fiscal Policy Shocks

This paper studies empirical facts regarding the effects of unexpected changes in aggregate macroeconomic fiscal policies on consumers that differ depending on individual characteristics. We use data from the Consumption Expenditure Survey to estimate individual‐level responses and multipliers for government spending. We find that unexpected fiscal shocks have substantially different effects on consumers depending on their income and age levels: the wealthiest individuals tend to behave according to predictions of standard Real Business Cycle (RBC) models, whereas the poorest ones behave according to standard IS–LM (non‐Ricardian) models, most likely due to credit constraints. Furthermore, government spending policy shocks tend to decrease consumption inequality.     

Macroeconomic Effects of Government Spending: The Great Recession was (Really) Different

We estimate the effect of government spending shocks on the U.S. economy with a time‐varying parameter vector autoregression. The recent Great Recession period appears to be characterized by uniquely large impulse responses of output to fiscal shocks. Moreover, the particularity of this period is underlined by highly unusual responses of several other variables. The pattern of fiscal shock responses neither completely fits the predictions of the New Keynesian model of an economy subject to the zero lower bound on nominal interest rates, nor does it suggest regular variation of fiscal policy effects depending on the state of the business cycle. Rather, the Great Recession period seems special in that government spending shocks had a strongly negative effect on the spread between corporate and government bond yields and a strongly positive effect on consumer confidence and private consumption spending.     

Fiscal policy with banks and financial frictions

We assess the role of banks to the transmission of optimal and exogenous changes in fiscal policy to the economy. We built-up a dynamic stochastic general equilibrium model with patient and impatient agents, banks and a government to find that banks and their associated capital-adequacy constraint mitigate the negative spill-over effects to the economy from higher taxes. Specifically, we confirm that labour income tax is the most distortionary fiscal instrument. The optimal choice of a housing tax is the most favorable funding source to a temporary increase in public spending. The combination of housing and labour taxes is the most preferred tax bundle to be optimally chosen under negative output shocks. Moreover, a permanent increase in housing tax is beneficial if it is welfare enhancing and the existence of banks benefits mainly impatient households under permanently higher consumption taxes. Finally, these results remain robust to various robustness checks.     

The Effectiveness of Fiscal Policy Over the Business Cycle: A CEE Perspective

In this article we analyze the effectiveness of fiscal policy—for a group of four Central and Eastern European countries. The recent literature shows that fiscal multipliers in the developed economies are higher during recession than expansion. So far, similar empirical analyses have been lacking for CEE countries. The results presented in this article show that fiscal multipliers in CEE countries differ with respect to the phase of the business cycle. Based on the SVAR methodology in which we allow for deterministic regime switching, we show that the government spending multipliers are significantly higher when the output gap is negative.     

Fiscal policy and external adjustment: New evidence

Relatively little empirical evidence exists about countries' external adjustment to changes in fiscal policy and, in particular, to changes in taxes. This paper addresses this question by measuring the effects of tax and government spending shocks on the current account and the real exchange rate in a sample of four industrialized countries. Our analysis is based on a structural vector autoregression in which the interaction of fiscal variables and macroeconomic aggregates is left unrestricted. Identification is instead achieved by exploiting the conditional heteroscedasticity of the structural disturbances. Three main findings emerge: (i) the data provide little support for the twin-deficit hypothesis, (ii) the estimated effects of unexpected tax cuts are generally inconsistent with the predictions of standard economic models, except for the US, and (iii) the puzzling real depreciation triggered by an expansionary public spending shock is substantially larger in magnitude than predicted by traditional identification approaches.     

Long‐Term Effects of Fiscal Policy on the Size and Distribution of the Pie in the UK*

This paper provides a joint analysis of the output and distributional long‐term effects of various fiscal policies in the UK, using a vector autoregression (VAR) approach. Our findings suggest that the long‐term impact on GDP of increasing public spending and taxes is negative, and especially strong in the case of current expenditure. We also find significant distributional effects associated with fiscal policies, indicating that an increase in public spending reduces inequality while a rise in indirect taxes increases income inequality.     

The revolutions in China’s inter-governmental fiscal system

There were three periods in the development of China’s inter-governmental fiscal system. In the first period (1950s to 1979), local governments collected tax revenues and remitted upward to the central government. Reforms during the next two periods made revolutionary changes to the system. The tax-sharing system (established in 1994) provides for revenue centralization, spending decentralization, and large central transfers to local governments. This system remains largely in force.     

The Government Spending Multiplier in Turkey

This study aims to measure the size of the government spending multiplier in Turkey for post-2001 financial crisis period within a structural VAR framework. The analysis demonstrates that a positive shock to government spending tends to increase output, tax, and real interest rate on impact and the size of the fiscal multiplier is relatively large at first few quarters. The fiscal multiplier reaches a peak value of 1.5 at second quarter and then starts to diminish. Furthermore, investigating the effects of the components of government spending reveals the fact that government investment expenditures, rather than consumption expenditures, have a profound impact on output at first few quarters.     

Signals from the government: Policy disagreement and the transmission of fiscal shocks

We investigate the effects of fiscal policy communication on the propagation of government spending shocks. To this aim, we propose a new index measuring the coordination effects of policy communication on private agents׳ expectations. This index is based on the disagreement amongst US professional forecasters about future government spending. The underlying intuition is that a clear fiscal policy communication can coalesce expectations, reducing disagreement. Results indicate that, in times of low disagreement, the output response to fiscal spending innovations is positive and large, mainly due to private investment response. Conversely, periods of elevated disagreement are characterised by muted output response.     

The Heterogeneous Responses of Consumption between Poor and Rich to Government Spending Shocks

Government spending shocks have substantially different effects on consumers across the income distribution: consumption increases for the poor whereas it decreases for the rich in response to a rise in government expenditure. I shed light on this issue by incorporating a progressive tax scheme and productive public expenditure into a heterogeneous agent model economy with indivisible labor. The model economy is able to successfully match aggregate and disaggregate effects of government spending shocks on consumption. When the government increases its spending and accompanies it by a rise in tax progressivity, the poor are employed and increase their consumption since after‐tax wage rates increase while the rich decrease their consumption because of a fall in after‐tax wage rates.     

Confidence and the transmission of government spending shocks

Is impacting confidence an important channel by which government spending shocks affect economic activity? In a standard structural VAR, an empirical measure of confidence does not significantly react to spending shocks and output multipliers are around one. In a non-linear VAR, confidence rises following an increase in spending during periods of economic slack and multipliers are much larger. The systematic response of confidence is irrelevant for the output multiplier during normal times, but is critical during recessions. Spending shocks during downturns predict productivity improvements through a persistent increase in government investment relative to consumption, which is reflected in higher confidence.     

Optimal money and debt management: Liquidity provision vs tax smoothing

Conventional wisdom on public debt management says that liquidity demand should be satiated and that tax rates should be smoothed. Conflicts between the two can arise when government bonds provide liquidity. Smoothing taxes causes greater variability in fiscal balances, and therefore in the supply of government liabilities. When prices are flexible, and can jump to absorb fiscal shocks, the tradeoff between liquidity provision and tax smoothing is eased; when they conflict, optimal policy subordinates tax smoothing to satiating liquidity demand. When price fluctuations impose real costs, conflicts necessarily arise and optimal policy gives primacy to neither goal.     

International spillovers from Euro area and US credit and demand shocks: A focus on emerging Europe

In this paper, we examine the international effects of contractions in loan supply, loan demand and aggregate demand in the euro area and the USA. All three shocks have been at the forefront in spreading stress during the period of the global financial crisis and in particular so to countries that are strongly integrated with the euro area. We find that these shocks decrease international output and total credit to a varying degree. Loan demand and aggregate demand shocks in the euro area trigger significant negative spillovers on output in most other regions. Evidence for global negative output effects of euro area loan supply shocks is fraught with considerable estimation uncertainty. When these three types of shocks emanate from the USA, we find significant negative spillovers on output also for loan supply shocks. In general, international effects on total credit are an order of magnitude larger than those on output, with again more evidence that is significant for US than euro area shocks. Last, and taking a regional stance, our results indicate that economies from emerging Europe are most vulnerable to all shocks considered. Through their strong economic integration with the euro area, these economies are likewise exposed to euro area and US shocks, and spillover effects are often larger than the domestic response in the country of shock-origin.     

Spending Reversals and Fiscal Multipliers under an Interest Rate Peg

This paper examines whether fiscal stimuli are more effective when the monetary policy is less responsive to inflation. First, we provide empirical evidence suggesting that, in the period of U.S. passive monetary policy, a positive government spending shock was followed over time by a spending cut. Second, our theoretical analysis reveals that the pegged nominal interest rate is not a sufficient condition to generate a large fiscal multiplier. An increase in government spending could increase the long‐run real interest rate, if it is associated with a government spending reversal and a less responsive monetary policy. Consequently, the response of private consumption can be negative and the government spending multiplier is not necessarily greater than 1.     

Unemployment,Government Spending and the Laffer Effect*

The paper studies the effects of income tax rate changes in a general equilibrium model with frictional unemployment. Laffer curve effects, by which a tax rate reduction may increase the level of government spending or its share in output, are shown to be possible under certain conditions. These are the presence of unemployment benefit payments, government budget balance through fiscal spending adjustment and limited quantitative importance of labour reallocation costs. Endogenous government spending acts as a fiscal accelerator if the fiscal burden of unemployment benefit payments is large, but reduces the employment effects of tax rate cuts if it is low.     

Fiscal Decentralisation and Local Economic Growth: Evidence from a Fiscal Reform in China

This paper uses a fiscal decentralisation reform in China – namely, the province‐managing‐county (PMC) reform – to examine the effects of fiscal decentralisation on local economic growth. The PMC reform abolished the subordinate fiscal relationship between prefectures and counties and transferred much of the tax and spending authority from the prefecture to the county level. Exploiting a county‐level panel data set over 2001–11, we find that the reform has led to a significant increase in the GDP growth rate. The effect is considerably more pronounced in regions with superior initial institutional quality. We also identify channels: the PMC reform induced county governments to exert lower tax burdens on firms and increase spending on infrastructure construction.     

After the death of inflation: will fiscal drag survive?

Declining inflation rates might have negative consequences for tax revenues. Phenomena such as the inflationary bracket creep in a progressive income tax system do not work any longer. With this background, the paper analyses the extent of fiscal drag for OECD countries since 1965. Some consideration of the role of money illusion and indexation in this context lays the theoretical base. A framework is presented that allows for the classification of fiscal structures with regard to the type of fiscal drag. The subsequent econometric panel analysis is performed for total and disaggregated government revenues. The results back theoretical considerations of inflation's impact on different kinds of taxes, which tends to be positive for individual income taxes and social security contributions and is negative for corporate income taxation. The paper concludes that both declining inflation and changing tax structures limit the potential for future fiscal drag.     

How big (small?) are fiscal multipliers?

Contributing to the debate on the macroeconomic effects of fiscal stimuli, we show that the impact of government expenditure shocks depends crucially on key country characteristics, such as the level of development, exchange rate regime, openness to trade, and public indebtedness. Based on a novel quarterly dataset of government expenditure in 44 countries, we find that (i) the output effect of an increase in government consumption is larger in industrial than in developing countries; (ii) the fiscal multiplier is relatively large in economies operating under predetermined exchange rates but is zero in economies operating under flexible exchange rates; (iii) fiscal multipliers in open economies are smaller than in closed economies; (iv) fiscal multipliers in high-debt countries are negative.