Download Government Spending & Fiscal Policy

Government Spending &
Fiscal Policy
Presented by:
Zahra Abdulkadir Amin
CONTENTS
 Government Spending
 Government Deficit
 Adjusting the deficit for inflation & the cycle
 Government Deficit and the national debt
 The stance of fiscal policy
 Applications on Kuwait
The scale of government spending
 Spending by the government can be classified into five main
categories:
£98.50
Consumption
1- Consumption
Debt interest
2- Current grants & subsidies
Capital
transfers
3- Debt Interest
£18.66
£8.25
4- Fixed Investment
£3.83
Current
grants and
subsidies
Fixed
Investment
£66.61
5- Capital Transfers
Figure in Billions
 Only Government consumption & Fixed investment enter the
GDP. The rest are transfer payments that do not form parts of the
GDP.
 Transfer
payments
are
a
redistribution of income & are nonexhaustive to the economy.
 Capital transfers are received by
businesses as grants.
Debt interests are received as
income
by
individuals
or
institutions.
 The
ratio
of
government
consumption to GDP is used to
assess the quantity of resources used
by the government.
%
 When measured using constant and current prices, the ratio of
government expenditures to GDP exhibit different fluctuation
rates.
 The price of government consumption has risen faster than the
GDP deflator.
The reason for that is that it’s difficult to measure improvements
in the quality of government services.
 Improvements are thus measured by the government spending,
by adding up the resources used, which fails to reflect the
productivity growth.
 Government investments in the UK
roughly halved remaining very law
since the 1970s.
 The fall in government investment
happened because the government was
obliged to reduce its spending.
 Government spending changes not
only as a response to changes in
economic policy, but also as a response
to structural changes in the economy.
THE GOVERNMENT DEFICIT
Measuring the deficit
 GD = Total government spending - Taxation.
Either the central government , all government or the whole
public sector is included.
 The two most important measures are : the Public Sector
Financial Deficit (PSFD) and the Public Sector Borrowing
Requirement (PSBR).
1- Public Sector Financial Deficit
 Used when we focus on the public sector as a whole. It
comprises government spending less income, plus the deficit
of public corporations.
Public Sector Borrowing Requirement
 When negative, it’s referred to as the Public Sector Debt
Repayment (PSDR).
PSBR= PSFD+ Net Lending
 The difference between the PSFD and PSBR is the ‘net lending to
the private sector and overseas’. This includes net purchases of
company securities.
 When public corporations are privatized, NL includes the
proceeds of privatization (revenues) which make it large and
negative.
Observing those two graphs we
notice:
 1960s: The deficit was small
using both measures. A small
surplus was then achieved in 19691970.
 1970-1974:
enormously.
the
 Both measures
greatly since 1983.
deficit
have
rose
fallen
 The gap between the two
increased due to the massive rise in
privatization proceeds.
£ Billion
Why does the government deficit matter?
 If it’s not financed by an increase in money
supply, it must be financed by borrowing.
 Large scale borrowing raises interest rates
causing the crowding out effect.
 How to finance the deficit depends on the
public view of shares and bonds.
Extreme Cases of the Public View
Case A
Case B
 Equities as riskier than
government bonds & a risk
premium is required.
 Equities are different from
bonds .
 Either using equities or
bonds, interest rates will be
raised by just much and rates
will rise and fall together
keeping RP constant.
 The best measure in this
case is the PSFD.
 Issuing equity has no effect
on the price of bonds &
interest rates.
 The focus is on PSBR.
 Prices of equities, however,
are affected & thus Tobin's q.
Adjusting for inflation and the cycle
Government deficit needs to be adjusted for the following:
1- Inflation tax
 Inflation tax is the economic disadvantage suffered by
holders of cash and its equivalents due to the effects of
inflation.
 Since government are the biggest debtors, inflation tax
transfers resources from the private sector to the government.
 Only the real cost of interest payments should.
Business Cycle
 A business cycle represents economywide fluctuations in production over a
long period of time.
 Even without any change in
government policy, the deficit varies
over the cycle.
 The cyclical adjustment can be
calculated creating the cyclically
corrected deficit.
 This is the deficit that would occur
given full employment, lower benefit
payments and higher tax revenues.
 The structural PSFD shows a
deficit in 1970s .
 1970s: The inflation adjusted
PSFD shows a surplus.
 During the 1980s a deficit
emerged due to the fall of
inflation reducing the inflation
tax.
 Main Causes: the large rise in
unemployment & the fall in
output, reducing the effect of the
contractionary policy.
Calculating the Inflation Tax
 Inflation makes debtors better off and creditors worse off.
 Inflation tax can be calculated as:
π.NML
Where NML= Nominal Government's net monetary liabilities.
 If r= average nominal interest rate on government bonds, &
r.NML=nominal interest payments then,
Real Interest Payments= Nominal Interest Payment- Inflation Tax
(r-π).NML= r.NML- π.NML
 Inflation changes yearly.
 Calculating the inflation tax
using the actual inflation rate can
vary greatly.
 An inflation rate based on a
longer term should be used,
called the expected inflation rate.
 The same measure should
apply to interest rates.
An ex ante inflation tax can be
calculated
using
expected
interest rates.
THE GOVERNMENT DEFICIT AND THE NATIONAL DEBT
Interest payments
 It’s argued that government
deficits raise interest payments.
 The real measure of the cost of
debt should be considered.
 Throughout the 1970s real
interest payments were negative.
 The real burden of interest rates
increased sharply since 1980s.
Government Debt
Note that:
It’s possible to run a deficit
without the real value of the debt
increasing if inflation is reducing its
real vale.
 Real Debt will increase only if the
inflation-adjusted
balance
is
negative.
 If GDP grows at a rate of 12%, the
government can run a deficit of 12%
of the national debt each year.
 If the growth rate of GDP (g) exceeds the real
interest rate in the long run, the ratio of
government debt to GDP will converge to a stable
equilibrium.
 1960s: National debt fell as a proportion of GDP
and since then has been approximately constant.
The ratio of debt to GDP is self limiting.
DYNAMICS OF DEBT AND DEIFICTS
Real deficit is divided into two parts; the
primary deficit and real interest payments:
γGDP+ (r-π) Debt
 Dividing by total debt, we obtain the
growth rate of the debt:
=(γGDP+ (r-π) Debt)/Debt
=γ(GDP/Debt)+ (r-π)
 The ratio of debt/GDP will be constant if
they grow at the same rate, thus:
γ(GDP/Debt)+ (r-π) = g
From this, it follows that:
Debt/GDP= γ/(g-r-π)
CONCLUSIONS:
POLICY
THE
SATANCE
OF
FISCAL
 Government deficit is the best measure of the stance
of the fiscal policy. However,
 Spending & Taxation affect the level of aggregate
demand independently of the size of the deficit
(balanced budget multiplier theorem).
 Different types of spending or taxation have
different multiplier affects.
 The way in which a deficit is financed affects the
level of aggregate demand.
Applications on
Kuwait
Government Spending, 2007/2008
By Economic Scale
By Chapter
25.54%
29.63%
42.86%
57.00%
18.23%
13.36%
12.44%
0.93%
Salaries
Services & Commodities
Transports & Installation
Construction, Maintenance & Public Expropriation
Other Expenses & Transferable payments
Current Expenditures
Transfer Expenditures
Capital Expenditures
Consumption
Real
Nominal
Investment
Real
Nominal
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
Billion KD
Development of the Kuwaiti Budget
10
Budget
Actual
8
6
4
2
0
-2
-4
-6
-8
-10
Year
Government Expenditures Trend by Chapter
7
6
Billion KD
5
4
3
2
1
0
1990
1992
1994
1996
1998
2000
2002
Year
Salaries
Services & Commodities
Transports & Installations
Construction & Maintenance
Other Expenditures & Transfer Payments
2004
2006
2008
The Kuwaiti Government Budget
Financial Year 2007/2008
Revenues (Million KD)
Budget
Actual
Diff.
7,450
870
8,320
17,719
1,304
19,023
10,269
434
10,703
Salaries
Services & Commodities
Transport & Equip. Installations
Construction & Maintenance
Others and transfer payments
Total Expenses (Million KD)
2,626
1,834
216
2,058
4,567
11,300
2,477
1,768
90
1,206
4,157
9,698
(149)
(66)
(126)
(852)
(410)
(1,602)
Future Generation Reservation
Commitments & Expenses
Budget Surplus/Deficit
832
12,132
(3,812)
1,903
11,600
7,422
1,071
(532)
3,610
Oil & Gas
Non Oil Revenues
Total Revenues
Expenses (Million KD)
DETERMINING GOVERNMENT EXPENDITURE MODEL
The government expenditures model can be formulated as:
G(t)= + Y+  G(t-1)+ 
Where G(t) is total government expenditures at time t, Y: real
output G(t-1) is government expenditures of the previous
year and  is the error term.
Using those parameters, the results obtained for Kuwait for
the period 1994-2007, is:
G(t)=-2890 +0.55Y+ 0.20 G(t-1)
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.95
R Square
0.90
Adjusted R
Square
0.88
Standard
Error
757.81
Observation
s
14.00
ANOVA
df
Regression
SS
MS
11.00
Total
13.00 62242100.59
Coefficients
Intercept
X Variable 1
F
2.00 55925117.49 27962558.74
Residual
6316983.10
Standard
Error
Significance
F
48.69
0.00
574271.19
t Stat
P-value
Lower 95% Upper 95% Lower 95.0% Upper 95.0%
-2889.91
1008.71
-2.86
0.02
-5110.06
-669.75
-5110.06
-669.75
0.55
0.15
3.77
0.00
0.23
0.88
0.23
0.88
Government Expenditures
Actual
12000
Estimated
8000
6000
4000
2000
Year
07
20
06
20
05
20
04
20
03
20
02
20
01
20
00
20
99
19
98
19
97
19
96
19
95
19
94
0
19
Million KD
10000
Estimating the Government Consumption Expenditures Model
C(t)= + Y+  C(t-1)+ R+
Where C(t) is the government consumption expenditures, Y the real
level of output, R is reserve money, C(t-1) is consumption expenditures
of the previous year and  is the error term.
Estimating the model, the result obtained is:
C(t)=-457 +0.04 Y+ 0.97 C(t-1)+ 0.14R
The log form can be taken to estimate the elasticities of the involved
parameters, such that:
Log C(t)=  + Log Y+  Log C(t-1)+  Log R +
Resulting in:
C(t)= -0.51 + 0.17Y+ 0.91C(t-1)+ 0.05R+
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.99
R Square
0.98
Adjusted R
Square
0.97
Standard
Error
123.05
Observations
14.00
ANOVA
df
SS
MS
F
Significance
F
143.84
0.00
Regression
3.00
6534244.34 2178081.45
Residual
10.00
151420.66
Total
13.00
6685665.01
Coefficient
s
Standard
Error
t Stat
P-value
Lower 95%
-456.54
224.06
-2.04
0.07
-955.79
42.71
-955.79
42.71
0.04
0.05
0.73
0.48
-0.08
0.16
-0.08
0.16
Intercept
X Variable 1
15142.07
Upper 95% Lower 95.0% Upper 95.0%
SUMMARY OUTPUT
(Log Form)
Regression Statistics
Multiple R
0.98
R Square
0.97
Adjusted R
Square
0.96
Standard
Error
0.02
Observations
14.00
ANOVA
df
SS
MS
F
Significance
F
Regression
3.00
0.11
0.04
108.35
0.00
Residual
10.00
0.00
0.00
Total
13.00
0.12
Coefficient
s
Standard
Error
t Stat
P-value
Lower 95%
Intercept
-0.51
0.25
-2.02
0.07
-1.07
0.05
-1.07
0.05
X Variable 1
0.17
0.27
0.63
0.54
-0.43
0.76
-0.43
0.76
Upper 95% Lower 95.0% Upper 95.0%
Government Consumption
Expenditures
5000.000
4500.000
3500.000
3000.000
Actual
Estimated
2500.000
2000.000
1500.000
1000.000
500.000
Year
07
20
06
20
05
20
04
20
03
20
02
20
01
20
00
20
99
19
98
19
97
19
96
19
95
19
94
0.000
19
Million KD
4000.000