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Rethinking Public Debt and Fiscal Policy Guillermo Calvo Columbia University www.columbia.edu/~gc2286 Credit Market Rupture 2 Normal Times SAVERS Private Sector DISSAVERS 3 Credit Sudden Stop SAVERS Private Sector DISSAVERS •The central problem is financial, and policy should focus on financial issues !! 4 Credit market Sudden Stop brings about excess supply of goods and services. “Lack of demand” is not a consequence of Sudden Anorexia or Sudden Loss of SelfEsteem! – However, these symptoms could develop afterwards as a result of drastic change in demand structure. Global Issues First priority is to normalize financial system. If the government can borrow at low interest rates, it makes sense to stabilize aggregate demand to prevent – Irving Fisher Debt Deflation – Excess relative price volatility. In addition, social programs to protect unemployed and the poor. However, high government expenditure crowds out private sector and may slowdown discovery of new equilibrium output pattern. This shows relevance of exit strategies. Fiscal deficit and large public debt are important issues but less critical than the previous ones in the short run. The Current Situation in the US It is much more serious than Sudden Stops in Emerging Market economies (EMs). Sudden Stops were followed by a sharp increase in exports, while in the US exports have declined. 8 Exports (Goods and Services, quarterly data, seasonally adjusted) 102 120 101 115 100 110 99 GDP 97 100 96 95 95 AEM - GDP AEM - Exports US - GDP US - Exports 94 93 92 90 85 80 2008-I t-1 2008-II 2008-III 2008-IV 2009-I t t+1 t+2 Source: Calvo and Loo-Kung (2010). t+3 2009-II 2009-III 2009-IV 2010-I t+4 t+5 t+6 t+7 2010-II 2010-III 2010-IV 2011-I t+8 t+9 t+10 t+11 Exports 105 98 Moreover, EM recovery was accompanied by a sharp fall in real wages and real currency devaluation. In contrast, US real wages are flat or increased, and the dollar has appreciated in real terms. 10 Real Exchange Rate (Bilateral RER vis-a-vis the US for AEM, Multilateral Effective RER for US, quarterly data, seasonally adjusted) 102 140 101 135 100 130 125 98 GDP 120 97 115 96 110 95 AEM - GDP AEM - RER US - GDP US - RER 94 93 92 105 100 95 2008-I t-1 2008-II 2008-III 2008-IV 2009-I t t+1 t+2 Source: Calvo and Loo-Kung (2010). t+3 2009-II 2009-III 2009-IV 2010-I t+4 t+5 t+6 t+7 2010-II 2010-III 2010-IV 2011-I t+8 t+9 t+10 t+11 Real Exchange Rate 99 Real Wages (Wages deflated by CPI) Average EM US 102 105 101 100 100 95 99 104 101 103 100 102 99 101 98 90 98 97 100 96 85 97 99 95 80 96 75 95 98 94 93 t (Peak) t+1 t+2 years quarters GDP Real Wages (right axis) Source: Calvo and Loo-Kung (2010). 97 t+3 As in EMs, bank credit in the US has dried up. Especially to small enterprises and households. Real Credit (Claims on Private Sector over CPI, quarterly data) 101 100 GDP 105 AEM - GDP AEM - Credit US - GDP US - Credit 103 101 99 99 98 97 97 95 96 93 95 91 94 89 93 87 92 85 2008-I 2008-II 2008-III 2008-IV 2009-I 2009-II 2009-III 2009-IV 2010-I 2010-II 2010-III 2010-IV 2011-I t-1 t t+1 t+2 Source: Calvo and Loo-Kung (2010). t+3 t+4 t+5 t+6 t+7 t+8 t+9 t+10 t+11 Real Credit 102 However, US Output is Recovering at a Rate Similar to EMs’ !! 15 Real GDP: AEM collapse vs. US subprime Crisis (quarterly data, seasonally adjusted) Peak Trough 104 Average EM GDP US GDP (data) US GDP (Consensus Forecast) 102 100 98 96 94 92 2008-I 2008-II t-1 t 2008-III 2008-IV t+1 t+2 2009-I 2009-II t+3 t+4 Source: Calvo and Loo-Kung (2010), www.voxeu.org. 2009-III 2009-IV t+5 t+6 2010-I 2010-II t+7 t+8 2010-III 2010-IV t+9 t+10 2011-I t+11 The US aggregate-demand drivers of output recovery are: Government Consumption Investment Government Consumption 102 105 101 104 100 103 99 102 98 101 97 100 96 99 95 98 AEM - GDP AEM – Gov. Cons. US - GDP US - Gov. Cons. 94 93 92 97 96 95 2008-I t-1 2008-II 2008-III 2008-IV 2009-I t t+1 t+2 Source: Calvo and Loo-Kung (2010). t+3 2009-II 2009-III 2009-IV 2010-I t+4 t+5 t+6 t+7 2010-II 2010-III 2010-IV 2011-I t+8 t+9 t+10 t+11 Government Final Consumption GDP (Gov. Final Consumption, quarterly data, seasonally adjusted) US Economic Predicaments Recovery is based on domestic aggregate demand, which does not help to resolve Global Imbalances. Fiscal stimulus is about to be phased out, and exports are weak, slowing growth. Domestic investment is likely to involve less labor-intensive activities, making employment-less recovery likely – which complicates politics and increases the probability of protectionism. US Macro Policy Dilemmas Doing nothing risks triggering price deflation. This is dangerous because it is a selfreinforcing mechanism. I would favor relaxing financial constraints for small firms (the Fed reports that banks are voluntarily starting to do that). Government expenditure exacerbates Global Imbalance and slows down discovery. – But it could be the solution of last resort if monetary/credit policy fails. Emerging Market economies Fiscal policy is less feasible because Flight to Quality is less likely to include EM public bonds. However, EM public bonds could be enhanced by World Bank programs. Infrastructure projects are attractive in many instances, and could be financed through PPP (Public-Private Partnership). EM government expenditure helps to resolve Global Imbalance. Inflation, not deflation, is a possible problem. Therefore, Inflation Targeting is still a valid objective. However, credit policy should not be ignored, especially during Sudden Stop. International Reserves could be used to extend foreign exchange credit to critical sectors, like the export sector (as in Brazil 2002 and 2008/9). Rethinking Public Debt and Fiscal Policy Guillermo Calvo Columbia University www.columbia.edu/~gc2286