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Targeting the Structural Balance
Laura Dos Reis, Paolo Manasse and Ugo Panizza
XXIV Meeting of the Latin American Network of
Central Banks and Finance Ministries
Inter-American Development Bank
Washington, DC, October 19, 2006
Motivation
• Should a country adopt a target for fiscal
policy?
• Should “fiscal rules” be used?
• Should they target a structural balance?
Outline
• The Cyclically Adjusted Balance:
Definition, Interpretation and
Implementation
• The Case for a Structural Balance Target:
Deficit Bias, Procyclicality
• The Case for Discretionary Fiscal Policy:
Virtuous Politicians, Creative Accounting,
Irrelevance
The Cyclically Adjusted Balance
•
Definition:
– What part in the changes in the fiscal stance is due to
changes in the environment and what part to changes
in policy?
•
Five possible interpretations (Blanchard, 1990)
1.
2.
3.
4.
5.
Index of discretionary fiscal policy
Index of permanent (“structural”) fiscal stance
Index of how fiscal policy affects the economy
Index of fiscal sustainability
Policy target
Problems of Interpretation
• CAB as a measure of discretionary fiscal policy
=> active vs. passive
• CAB as a measure of “structural” policy stance =>
temporary vs. permanent shocks
• CAB as an indicator of the impact of fiscal shocks
on the economy => balanced budget multiplier
• CAB as an indicator of fiscal sustainability =>
real interest rate, rate of growth, debt structure
• CAB as policy target : => optimal level of public
savings? Let automatic stabilizer operate?
Problems of Computation
•
Decomposition between trend and cycle
–
–
–
The detrending method matters
“Forward looking filters” require future data
Data revisions affect the decomposition
Data revision and CAB for Brazil
Output Gap in 1990 (% of Potential output)
Figure 1: 1990 Brazil’s Output Gap Measured in Different Periods
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Year of measurement
Impact of GDP Revisions on CABs:
Spring 2003 vs. Autumn 2003 EC Release
Revision to GDP Growth Rates
Elasticity of
Revisions to CABs
(percentage points)
Balance to Cycle
(percentage points of GDP)
2001
2002
2003
2004
2001
2002
2003
2004
2005
Austria
0.1
0.3
-0.2
-0.1
0.3
0.00
0.02
0.05
0.08
0.12
Belgium
-0.1
0.0
-0.4
-0.5
0.6
-0.16
-0.20
-0.24
-0.26
-0.26
Finland
0.6
0.6
-0.8
-0.4
0.7
-0.04
-0.09
-0.17
-0.29
-0.45
France
0.3
0.1
-1.1
-0.6
0.4
-0.08
-0.15
-0.23
-0.31
-0.39
Germany
0.3
0.0
-0.4
-0.4
0.5
0.00
-0.02
-0.04
-0.07
-0.08
Greece
0.0
-0.2
0.4
0.4
0.4
0.04
0.08
0.13
0.18
0.23
Ireland
0.5
0.9
-1.8
-0.8
0.4
0.06
-0.06
-0.24
-0.49
-0.78
Italy
0.0
0.0
-0.6
-0.6
0.5
-0.11
-0.19
-0.29
-0.40
-0.53
Luxembourg
0.1
0.9
0.1
-0.8
0.6
0.95
1.08
1.15
1.18
1.16
Portugal
0.0
0.0
-1.3
-1.1
0.4
-0.18
-0.31
-0.48
-0.66
-0.85
Spain
0.2
0.0
0.3
-0.2
0.4
0.08
0.08
0.18
0.25
0.32
The Netherlands
0.0
-0.1
-1.4
-1.1
0.7
-0.31
-0.52
-0.78
-1.06
-1.33
Average absolute
0.2
0.3
0.7
0.6
0.17
0.24
0.33
0.44
0.54
revision
Problems of Computation
• Decomposition between trend and cycle
–
–
–
–
–
Output = Trend + Cycle
What detrending method should be used?
Most “filters” (HP) need future data
Data revisions affect the decomposition
Things are even more complicated in EM
countries where it is not clear what is the trend
and what is the cycle (Aguiar and Gopinath,
2004)
Problems of Computation
• Estimate Revenue & Expenditure
elasticities to output => Balance elasticity
- Information on the source of change in the
balance
- But not directly relevant for the question of
CAB
- Estimation errors?
Outline
• The Cyclically Adjusted Balance
• The Case for a Structural Balance Target
• The Case for Discretionary Fiscal Policy
The Case for Structural Balance
• A fiscal rule can reduce the deficit bias of
myopic politicians
– However a simple fiscal rule can lead to
procyclicality (tradeoff credibility stabilization)
• A fiscal rule defined in terms of a CAB can
reduce deficit bias while allowing for the
conduct of countercyclical fiscal policy
The Case for Structural Balance
• Procyclicality
– First documented by Gavin and Perotti (1997) and then
corroborated by several others
– Also present in industrial countries but only during
good times
– Possible explanations
• Poor institutions
• Procyclical capital flows
• Rules?
– Evidence that fiscal rules reduce the deficit bias and
also procyclicality
The Case for Structural Balance
Fiscal Rules, Deficit Bias and Procyclical Policy
Dependent Variable: Primary surplus/GDP
Outline
• The Cyclically Adjusted Balance
• The Case for a Structural Balance Target
• The Case for Discretionary Fiscal Policy
The Case for Discretion
• Unnecessary constraints to virtuous politicians
– When institutional quality is controlled for, fiscal rules
do not matter anymore (Manasse (2006))
– So rules maybe endogenous
– Useless but not harmful: they may even give some
ammunition to a virtuous policy-maker
– However, a CAB rule may force a virtuous politicians
to spend too much if people think that trend growth has
increased
The Case for Discretion
• Creative accounting
– Rules may create incentives for creative
accounting
– The incentive for creative accounting may be
reduced or raised by a simpler (i.e unadjusted
balance based) rule
• More difficult to trick the data
• More incentive to trick the data
The Case for Discretion
• Setting limit on deficits may not suffice for
preventing debt explosions
– Change in Debt = Deficit+ Stock-Flow Adj
– SF is huge (creative accounting may be part of
this, see Campos, Jaimovich, and Panizza 2006)
Contribution to debt growth of extra-budgetary items
(balance-sheet effects, skeletons, etc.)
18
16
14
Percent of GDP
12
10
8
6
4
2
0
-2
1995
1996
1997
1998
1999
2000
2001
2002
2003
Simple average for: Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela
2004
2005
The Case for Discretion
• Procyclicality might be less important than
previously thought
– Reverse causality: fiscal expansion causes a
boom (and not vice versa), see Rigobon, 2004,
Jaimovich and Panizza, 2006)
Issues for Discussion
• Can CAB rules play a useful role or do they
impose unnecessary constraints?
• Can EMs confidently estimate trend and cyclical
output?
• Is creative accounting an issue?
• Are independent fiscal councils a good idea?
– To prepare non-forecast for revenues and growth
– Can decision of the size of the budget balance be
delegated to an independent authority?
Issues for Discussion
• Even if CAB rules can play a useful role,
implementing such rules is the best way to
spend scarce political capital?
• Is the sequencing important? Should more
modest budget reforms (transparency,
hierarchical rules, FRL) come first?