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SEMINARIO PERMANENTE DE LAS IDEAS: Economía, Población y Desarrollo. Cuerpo Académico Número 41 www.estudiosregionales.mx. 1. Public Finance and Monetary Policies as Economic Stabilizer: Unique or Universal Across Countries? DRA. ARWIPHAWEE SRITHONGRUNG Public Finance Center; - PowerPoint PPT PresentationTRANSCRIPT
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SEMINARIO PERMANENTE DE LAS IDEAS:Economía, Población y Desarrollo
Cuerpo Académico Número 41www.estudiosregionales.mx
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Public Finance and Monetary Policies as Economic Stabilizer: Unique or Universal Across Countries? DRA. ARWIPHAWEE SRITHONGRUNG
Public Finance Center;
Wichita State University,
Ciudad Juárez, Octubre 13 2014
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INTRODUCTION Motivation of the study
Does monetary policy work better than fiscal policy in developing countries?
Lack of systematic test for stabilization policy in developing countries
Non-industrialized countries Low-to medium-income levels;
Research question In what circumstances is monetary policy effective in
stabilizing an economy and in what circumstances is fiscal policy a better tool to do the same?
Theoretical arguments Asymmetric information in capital markets Stabilizing economy at the least social cost
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THEORETICAL BACKGROUND (1) Musgrave, R. (1959): public finance functions
and roles Correct market failures
Public infrastructure Public programs Tax revenue, public budgeting, government consumption
and investment Redistribute resources from rich to poor
Social programs Income tax structure Current transfer payment
Stabilize macro-economy Fiscal policy: tax, spending and deficit finance Monetary policy: central bank interest rate
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THEORETICAL BACKGROUND (2) Basic roles of fiscal and monetary policies
Mundell-Fleming’s (1963) IS/LM Model Sticky prices in short run Fiscal and monetary policies to change output levels
Interest rate: directly change investment and consumption level
Public spending, taxes and deficit finance: indirectly change investment and consumption by re-shuffling resources
Open economy with fixed exchange rates Fiscal policy: deficit finance and tax cut
investment/consumption change interest rate foreign investment change
Open economy with floating exchange rates Monetary policy: interest rate foreign investment - domestic
currency demands/supply export level 6
THEORETICAL BACKGROUND (3) Relax IS/LM Model by adding public debt
accumulation Two contrasting views: finite and infinite-horizon Finite-horizon assumption
Beetsma & Bovenberg, 1995; Durham, 2006; Shabert, 2004; Piergallini; 2005; Bartolomeo & Gioacchino, 2008
Fiscal policy: both fixed and floating exchange rates Economic agents:
---anticipate central bank’s inflation strategies ---assume life-cycle cost; debt is postponed to the next
generations Government liabilities affect aggregate demand and thus
generate wealth Unintentional effect of monetary policy
---agents guess central bank strategy ---cut employment and inputs without necessary reasons
Counter-cyclical fiscal policy 7
THEORETICAL BACKGROUND (4) Infinite-horizon assumption
Kirsanova, Stehn, Vines, 2005; Clarida, Gali & Gertler, 1999; Romer & Romer, 1996; Stehn & Vines, 2007
Monetary policy: both fixed and floating exchange rates Economic agents
--expect inflation and recession in the future --do not pass debt service burden to future generation --do not react to tax and government spending
Taylor rule: set nominal interest rate to target real inflation and recession
--bad times: decrease nominal interest rates for several periods, followed by deficit finance
--good times: increase nominal interest rates for several periods; followed by tax increase
Unintentional effects of fiscal policies --tax increase/surplus in early inflation period- dampens
investment; agents expect future recessions --deficit finance in early recession coupled with high debt
accumulation -- higher interest rates- force public spending cut negative impacts on employment and low-wage workers
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THEORETICAL BACKGROUND (5)
Typically high-income Complete capital
markets—controllable cash inflows
Relatively high human development index
Relatively high institutional quality
Relatively lower fiscal burden
Mankiw, Wienzierl, Blanchard, Eggertsson, 2011; Christiano, Eichenbaum & Robelo, 2009
Relatively high public debts
Relatively low government accountability
Relatively low government credibility
Incomplete trading system, opaque national account, high level of government deficits
Imcomplete capital markets
Hasan & Isgut, 2009; Fielding, 2008; El-Shagi, 2012
OECD Countries Non-OECD Countries
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THEORETICAL BACKGROUND (6) Fiscal and monetary policies economic growth Warren Smith (1957)
Structurally balanced economy: Full employment and production is achieved in current year In the following year, tax burden must be less than investment The ratio of private investment to GDP is greater than the ratio of
government revenue to total national income Resource allocation between public and private sectors
is optimal Business cycles create random shocks but do not
interrupt long-term growth Rarely occurs; private investment depends on
Current-year investment level and profits Profit tax Government consumption
Current year investment over optimal level- inflation Current year investment under optimal level --
recession
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THEORETICAL BACKGROUND (7) Fiscal and monetary policies economic growth David Smith (1960),
Relaxes closed-economy assumption : In addition to domestic investment and consumption Balanced payment in national account due to a country’s levels of
export, import and disposable income Open economy allows for spillover effects
Maintaining balance of payments is key Direct policy tools, e.g., tariff taxes, import controls,
periodic exchange rate devaluation can control balance of payments
Monetary policy enhances growth Indirectly changes investment levels especially when faced with
foreign growth Fiscal policy enhances growth
Tax increases discourage consumption Cautions: in situations with incomplete capital markets
and fixed tax systems fiscal policy is more effective
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THEORETICAL BACKGROUND (8)
Hypothesis 1: In OECD countries, fiscal policy through deficit finance and public spending is ineffective [due to economic agents’ anticipation; while monetary policy is effective because interest rates provide incentives for private investment]
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THEORETICAL BACKGROUND (9) Capital markets / institutional quality of
government (El-Shagi, 2012) Intensity of cash inflow control Quality and intention of capital market regulation
Western/industrialized or high-income countries Capital markets designed to limit exposure to foreign risks Capital market transparency Inflow and outflow levels are compatible
Non-industrialized or medium-to low-income countries
Capital markets designed to enhance local cash supplies Capital market rules and regulation is arbitrary Transaction approvals are opaque
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THEORETICAL BACKGROUND (10) Quality of government and ability to monetize
(Fielding, 2008; Calvo, Leiderman, Reinhart, 1996; Kaminsky, Rinehart & Vegh, 2004) Western/industrialized or high-income countries
Capital inflows rising Create domestic currency demands Foreign investments increase; generating long term growth
Non-industrialized or medium-to low-income countries
Capital inflows rising Create inflation pressure Domestic currency appreciates; dampening export
Consequences for non-industrialized and medium to low-income economies Low domestic currency demands, national saving -- inelastic
rate Public debt fails to absorb inflation, unless set extraordinary
high
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THEORETICAL BACKGROUND (11)
Summary for monetary policy
Mankiw, Wienzierl, Blanchard, Eggertsson, 2011 monetary policy: counter-cyclical; interest rate is an effective tool to mitigate inflation
and recession Kaninsky, Rienhart & Vegh, 2004
fiscal policy tends to be cyclical coupled with the incomplete capital market problems
Easterly and Schmidt-Hebbel (1993) in developing countries, good financial management
through well-planned taxing and spending leads to growth
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THEORETICAL BACKGROUND (12)
Hypothesis 2: In non-OECD countries, fiscal policy through public spending is effective in stabilizing economies, while monetary policy is ineffective [since current account balance does not readily adjust to reflect true levels of capital inflows]
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METHODOLOGY AND DATA (1)
Fischer (1993):
where;
is per capita real Gross Domestic Product (GDP),
is inflation rate,
b is balance account payment,
is government spending rate,
is interest rate and
is capital accumulation rate
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METHODOLOGY AND DATA (2)
Panel Vector Autoregression (PVAR) Endogenous system of equations Reproducing Fischer’s system
Addresses endogeneity Needs appropriate lag length to reduce errors to
white noise
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METHODOLOGY AND DATA (3)
Sample Countries
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OECD Member Countries (19) Non-OECD Member Country
(17)
Belgium, Canada, Denmark,
Finland, France, Greece,
Iceland, Ireland, Italy, Japan,
Netherlands, New Zealand,
Norway, Portugal, Spain,
Sweden, Switzerland, United
Kingdom, United States
Algeria, Barbados, Fiji, Hong Kong,
Jordan, Kuwait, Mauritius,
Pakistan, Paraguay, Peru,
Philippines, South Africa, Sri
Lanka, Thailand, Trinidad &
Tobacco, Uruguay, Venezuela
METHODOLOGY AND DATA (3) Summary Statistics: OECD Countries (with high
income)
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Variables Mean
Standard Deviation
Minimum Maximum
Current Account Balance (% to GDP) ( ) -0.3 5.2 -28.4 16.5Gross Fixed Capital Formation rate (% to GDP) () 21.3 3.5 12.0 34.5
Per Capital Real GDP (Constant $ value) ( )
27,814
7,579
10,806
51,792 Government Spending Rate (% to GDP) ( ) 7.1 1.6 3.0 11.3Central Bank Discount Rate ( ) 7.5 6.0 0.0 49.0
Annual Change Central Bank Discount Rate ( -0.3 2.7 -25.0 28.0
Annual Change Per Capita Real GDP ( 429 846 -5609 4308Annual Change Government Spending Rate (% to GDP) ( 0.0 0.3 -1.4 1.8Annual Change Gross fixed capital Formation rate (% to GDP) ( -0.2 1.4 -10.5 6.2Annual Change Current Account Balance (% to GDP) ( 0.1 2.2 -12.6 16.8
METHODOLOGY AND DATA (3) Summary Statistics-Non-OECD Countries (with medium-
to low-income
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Variables Mean
Standard Deviation
Minimum
Maximum
Current Account Balance (% to GDP) ( ) 0.41 14.35 -242.19 54.57
Gross Fixed Capital Formation rate (% to GDP) () 21.7 5.81 9.5 43.2
Per Capita Real GDP (Constant $ value) ( ) 9,617 10,382 1,170 52,502
Government Spending Rate (% to GDP) ( ) 7.76 3.45 2.82 29.40
Central Bank Discount Rate ( ) 21.96 61.03 0.00 866.00
Annual Change Central Bank Discount Rate ( -0.17 47.60 -576.00 718.00
Annual Change Per Capita Real GDP ( 158 1,172 -10,315 9,690Annual Change Government Spending Rate (% to GDP) ( -0.01 1.20 -11.15 11.62
Annual Change Gross fixed capital Formation rate (% to GDP) ( -0.17 3.27 -19.40 21.30
Annual Change Current Account Balance (% to GDP) ( 0.06 16.70 -262.53 239.92
RESULTS: OECD GROUP
Variable Per Capita GDP Response Size
Year t
Year t+1
Year t+2
Year t+3
Year t+4
Year t+5
Year t+6
Cumulative Effect Across
Time
Lower Bound (95% CI) 665.4 326.4 10.5 13.4 9.6 -38.3 -32.4 $ 1,025
($846)
Point Estimate 706.6 394.8 106.8 142.2 108.4 65.9 50.6 $ 1,459
Upper Bound (95% CI) 746.6 469.7 218.1 259.8 215.4 175.7 149.7 $ 1,910
Lower Bound (95% CI) 0 -160 -280 -200 -130 -49.7 -49.5 $ (770)
(2.7%)
Point Estimate 0 -82.8 -210 -130 -70.8 13.8 5.3 $(494)
Upper Bound (95% CI) 0 -16.2 -130 -70.3 -9.7 76.3 59.1 $(226)
Lower Bound (95% CI) 0 -47.7 -18.8 17 -25.4 -21.9 -48.8 $0
(.3%) Point Estimate 0 4.3 41 84.3 45.9 31.4 9.3 $0
Upper Bound (95% CI) 0 54.8 102.1 151.3 111.2 91 66.3 $0
Lower Bound (95% CI) 0 -32.3 -160 -260 -220 -170 -120 $0
(1.4%) Point Estimate 0 58.9 -64.3 -160 -130 -110 -50.4 $0
Upper Bound (95% CI) 0 163.5 19.2 -45.4 -45.7 -36.8 11.6 $0
Lower Bound (95% CI) 0 -210 -120 -58.2 -120 -92.2 -83.5 $0
(2.2%) Point Estimate 0 -150 -38.5 56.1 -28.7 -7 -17 $0
Upper Bound (95% CI) 0 -85.5 56.5 145.4 48.1 61.3 42.1 $0
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RESULTS: OECD IMPULSE RESPONSE
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t t+1 t+2 t+3 t+4 t+5 t+6
-$300
-$250
-$200
-$150
-$100
-$50
$0
$50
$100
Response of Per Capita Real GDP to Shock in Discount Rate
Per
Cap
ita R
eal G
DP (
$)
RESULTS: OECD IMPULSE RESPONSE
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t t+1 t+2 t+3 t+4 t+5 t+6
-$100
-$50
$0
$50
$100
$150
$200
Response of Per Capita Real GDP to Shock in Government Spending
Per
Cap
ita R
eal G
DP (
$)
RESULTS: NON-OECD GROUP
Variable Per Capita GDP Response Size
Year t
Year t+1 Year t+2 Year t+3 Year t+4 Year t+5 Year t+6
Cumulative Effect Across Time
Lower Bound (95% CI)
901 -36.9 172.7 -190 21.3 -74.2 -37.3 $ 1,095
($1,172)
Point Estimate 962.4 209.8 292.8 -9.9 176.5 56.8 44.8 $ 1,432
Upper Bound (95% CI)
1000 439.2 481.2 168.1 341.7 204.6 202.1 $ 1,823
Lower Bound (95% CI)
0 -41.9 -23.6 -77.4 -6 -63.3 -15.8 $ 0
(48%) Point Estimate 0 -4.5 31 -23.1 38.4 -19 18 $ 0
Upper Bound (95% CI)
0 35.7 82.2 25.6 93.8 11.6 48.7 $ 0
Lower Bound (95% CI)
0 207.7 87 15.3 5.5 6.4 3 $ 325
(1.2%) Point Estimate 0 348.3 256.1 141.4 99.3 98.6 82.4 $ 1,026
Upper Bound (95% CI)
0 507.6 453.9 367.6 267.2 269.9 240.7 $ 2,107
Lower Bound (95% CI)
0 -150 -61.9 -390 -88.8 -140 -43.3 $(390)
(3.3%) Point Estimate 0 -10.6 41.4 -230 -27.6 -50.1 8.5 $ (230)
Upper Bound (95% CI)
0 134.3 145.6 -55.3 50.8 13.8 70.5 $ (55)
Lower Bound (95% CI)
0 -200 2 -92.3 -74.4 -62.4 -16.1 $(198)
(16.7%) Point Estimate 0 -110 124.3 -24 -11.3 -13.2 20.6 $ 14
Upper Bound (95% CI)
0 -23.8 249 45.9 42.2 37.9 72 $ 225
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RESULTS: NON-OECD IMPULSE RESPONSE
26t t+1 t+2 t+3 t+4 t+5 t+6
$0
$100
$200
$300
$400
$500
$600
Response of Per Capita Real GDP to Shock in Government Spending
Per
Cap
ita R
eal G
DP (
$)
RESULTS: NON-OECD IMPULSE RESPONSE
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t t+1 t+2 t+3 t+4 t+5 t+6
-$100
-$50
$0
$50
$100
$150
Response of Per Capita Real GDP to Shock in Discount Rate
Per
Cap
ita R
eal G
DP (
$)
DISCUSSION (1)
OECD Countries Central bank discount rate negatively related to economic
growth
For every one standard deviation shock decrease (2.7%), real per capita GDP increases by about $495 (one standard deviation PC GDP = $846)
The monetary policy effect is persistent across 4-year period
No effect for monetary policy for the year in which the policy is introduced
No significant effect of fiscal policy 28
DISCUSSION (2) Non-OECD Countries
Government spending is positively related to economic growth
For every one standard deviation of government spending increase (1.2%), real per capita GDP increases by about $1,026 ( one standard deviation GDP = $1,172)
The fiscal policy effect on output is persistent across 6-year period
No effect of fiscal policy in the same year as the policy is introduced
Monetary policy is not statistically significant 29
CONCLUSION Three viewpoints
Currency exchange system Finite-horizon assumption/Infinite-horizon assumption Capital market and institutional quality/openness and
foreign growth and declines
Theoretical contribution To choose economic policy, it’s not only about economic
agents’ response and exchange rate systems,…………… but also quality/intention of capital market regulation
Practical contribution For developing, fiscal policy stabilizes output while shifting
wealth among sectors
Limitation The model lacks exogenous variables Fails to explain the path in which fiscal policy stabilizes
output30