Download Document

Fiscal Policy, Budget
Deficits and Government
Debt
Week 9
SF Intermediate Economics
Professor Dermot McAleese
OUTLINE
 Counter-cyclical fiscal policy
 “Crowding-out”
 The limits of fiscal activism
 Public debt + “ageing” of population
COUNTER-CYCLICAL
FISCAL POLICY
The Keynesian aggregate supply curve and fiscal policy
Price
level
KAS
E
1
E2
E*
AD1
AD
AD2
Y2
Y*
Output
CROWDING OUT
 Crowding out refers to the various ways by
which changes in public spending impact
negatively on private sector spending.
(+)G

(+) Budget Deficit 
borrowing

(+) r
 (-) I, (-) C
BD matched by (+) LM offsets crowding out effect
r
LM
IS’
IS
Y
RICARDIAN EQUIVALENCE
(-) T today (+) Budget Deficit today
(+) Govt borrowing  (+) T tomorrow
 (-) C today
 The stimulus to AD by budget deficit will be offset
by a rise in private sector saving
 Financing by borrowing = increase in taxation
 Rational expectations
FISCAL ACTIVISM: THE LIMITS
 Knowledge gaps and time lags
 Political interference
 Inefficiencies of the public sector
 Deterrent effects of public debt overhang
 Private sector response
 Empirical experience
The Debt Penalty - Limits to Public Borrowing
Public debt is sustainable when it remains constant
proportion of GDP over time (see formula in Appendix)
Effect on financial markets’ expectations:
 inflation to erode real value of fixed interest debt
debt default, rescheduling or moratorium on
interest payments
New measures of indebtedness (public debt adjusted for net
pensions liabilities)
Openness of the financial markets  fiscal conservatism
Further reinforced by ageing
EMPIRICAL EXPERIENCE
 Fiscal policy often pro-cyclical instead of
counter-cyclical
 Private sector response not always positive
Extreme Cases
expansionary fiscal contraction (Ireland?)
extreme incipient indebtedness (Japan)
surplus for an ageing population (Norway)
CONCLUSION
 Coarse-tuning instead of fine-tuning
 Effectiveness of fiscal policy depends on:
initial position (public debt, size of public sector)
 political institutions (credibility)
Table. 1 Industrial countries: fiscal balances (% GDP)
1990
1993
1996
2000
-3.6
-6.5
-4.5
-0.6
2.9
-2.5
-3.3
-1.6
-10.9
-1.2
-4.1
-1.4
-3.4
-3.3
-6.1
-9.6
-7.8
-7.3
-3.9
-1.3
-4.0
-4.0
-6.7
-4.4
-2.4
-8.4
1.0
-0.7
-1.5
-1.5
0.2
2.3
Spain
-3.9
-7.5
-4.7
-0.8
Netherlands
-5.1
-3.3
-3.1
0.8
Belgium
Sweden
-5.4
4.2
-6.6
-13.4
-3.2
-5.0
-0.5
2.0
Austria
Denmark
-2.2
-1.5
-4.1
-4.5
-4.5
-1.3
-1.7
2.0
5.3
-14.0
-8.0
-12.1
-2.9
-7.6
4.6
-1.5
Portugal
Ireland
Switz erland
-5.4
-2.5
-2.1
-7.0
-2.7
-4.3
-4.0
-2.4
-2.7
-1.8
3.2
-1.2
Norway
4.2
-1.4
3.8
7.3
Iceland
-3.3
-4.5
-2.4
0.8
Australia
0.4
-3.9
-0.1
0.3
New Zealand
-2.3
-0.7
3.6
0.3
European Union
Japan
USA
Germany
France
Italy
UK
Canada
Finland
Greece
Source: IMF, World Economic Outlook (May 1996 and May 2000)
Table. 1a Industrial countries: fiscal balances (% GDP)
1990
1993
1996
2000
European Union
-3.6
-6.5
-4.5
-0.6
Japan
USA
2.9
-2.5
-1.4
-3.4
-3.9
-1.3
-8.4
1.0
Italy
-10.9
-9.6
-6.7
-1.5
Netherlands
Greece
Ireland
-5.1
-14.0
-2.5
-3.3
-12.1
-2.7
-3.1
-7.6
-2.4
0.8
-1.5
3.2
4.2
-1.4
3.8
7.3
Norway
Source: IMF, World Economic Outlook (May 1996 and May 2000)
Table. 2 Fiscal policy stance, 1999-2000
1990
2000
Change
2.9
1.2
1.7
-8.4
-1.8
-6.6
-11.3
-3.0
-8.3
-3.6
-0.6
0.3
1.6
-0.4
-2.0
-5.2
-0.2
5.0
-2.7
1.0
3.7
1.1
0.5
-0.6
-3.8
0.5
4.3
Japan
Total of which:
Cyclical
Structural
European Union
Total of which:
Cyclical
Structural
United States
Total of which:
Cyclical
Structural
Source: IMF, World Economic Outlook (May 1996 and May 2000)
Table. 3 Government spending (%GDP)
Pre-WWII (about
1937)
1960
1970
1984
1990
2000
EUR
29.0
32.2
37.4
50.0
48.1
44.0
Japan
US
25.4
8.6
17.1
27.0
19.4
31.6
32.9
35.6
32.3
36.8
31.8
33.4
France
29.0
34.6
38.9
52.5
50.6
47.7
Germany
Netherlands
Ireland
Italy
42.4
19.0
…
24.5
32.5
33.7
28.0
30.1
38.5
42.4
39.6
34.2
47.6
59.6
51.3
49.4
45.3
55.0
40.0
53.2
44.0
42.1
29.5
44.2
UK
30.0
32.2
37.3
45.3
40.3
36.8
Source: European Economy, Annual Report No 59, 1995; European Economy, special
Supplement, Spring 1995; OECD; pre-Second World War figures taken from Vito Tanzi
and Ludger Schuknecht, ‘The Growth of Government and the Reform of the State in
Industrial Countries’, IMF Working Paper, December 1995; European Economy No. 68,
1999.
Table. 4 General government net debt (%GDP)
1978
1990
1995
2000
EU(15)
23.9
40.8
75.2
68.5
Japan
US
11.3
21.3
9.5
31.5
76.2
74.5
112.8
60.2
Belgium
Italy
57.2
62.4
124.9
103.7
129.8
123.1
109.8
112.9
Greece
29.4
89.0
108.7
103.8
Netherlands
40.2
75.6
75.5
56.5
Denmark
21.9
65.8
73.9
50.8
Portugal
Germany
France
37.6
30.1
31.0
65.3
42.0
39.5
65.9
59.1
59.3
58.8
63.5
63.9
Spain
14.4
48.5
68.4
65.7
UK
58.6
39.1
58.9
49.7
Ireland
65.7
92.6
80.8
42.9
Source: European Monetary Institute, First Annual Report, April 1995; OECD Economic
Outlook,, various issues.
Table. 5 Elderly dependency ratios
1960
2000
2050
US
9.2
12.4
21.2
Japan
6.1
16.5
30.4
EC15
10.6
16.1
27.6
Source: Eurostat
Table. 6 Public sector debt and net public pensions
liabilities, 1990 (% GDP)
Public debt
Net
pensions
liabilities
Extended
public debt
US
56
43
99
Japan
70
200
270
Germany
44
160
204
France
47
216
263
Italy
101
233
334
UK
35
100
135
Source: Van Noord and Herd (1994)