Discussion ofFiscal policy in open economies:

estimates for the Euro Area

By Lorenzo Forni and Massimiliano Pisani

Michel Strawczynski

Thursday, October 29th

• General Equilibrium.

Features of the Model

• General Equilibrium.

• Open Economy.

• Both Ricardian and Liquidity-Constrained Consumers.

• Monetary Policy by Taylor Rule.

• Government budget composition: direct and indirect taxes; government consumption, investment and transfers.

Comparison to a Recent Contribution

“Fiscal stimulus with spending reversals”, Corsetti, Meier and Mueller (2009) :

• That paper is richer than this one on the dynamics of future fiscal policy adjustment.

• This paper is richer on the detailed instruments (different government expenses and taxes).

• General Equilibrium.

Contributions

• Overall Fiscal policy multipliers.• Fiscal multipliers (4 months):

government consumption – and not public expenditure (table 4) - (0.73), transfers (0.18), capital taxes (0.03), wage taxes (0.67), consumption taxes (0.71).

• Impact on BOP and real exchange rate.

Two Comments

• I. The result on transfers must be checked in light of the possibility on concentrating transfers on liquidity constrained individuals. The effect on output “on impact” (0.25) is much lower than government consumption (1) and labor (0.5) and consumption (0.6) taxes.

• II. Given the richness of instruments, it is important to test government investment.

Comment I

– I find the result on transfers quite puzzling: the multiplier is a quarter of the one for taxes.

– This result derives from a relatively low increase in consumption on impact by Non-Ricardian consumers (0.5), and an extremely sensitive offset by Ricardian consumers.

– I will now argue that on impact the effect is higher.

– Concerning taxes, the Ricardian offset is low, because of intertemporal substitution.

Transfers

• Usually concentrated on Non-Ricardian consumers, as assumed here.

• The MPC, specially in crisis periods, is close to 1. Thus, the impact might be at least equal compared to government consumption.

• The inexistence of cycle-contingent provisions (f.e. freeing employee funds) makes a clear case for liquidity constraints.

Private consumption in the Euro 16 Area (source: ECB)

GDP

1020000

1070000

1120000

1170000

1220000

1270000

1320000

1370000

1650000

1750000

1850000

1950000

2050000

2150000

2250000

2350000

2450000

consumption

Total Reduction in Consumption

Reduction in: Consumption GDP

25

In Current Prices % In Current Prices %

25,809 1.96 89,085 3.83

Percentage of liquidity constraints consumers under the assumption of MPC of 1:

0.51

(Right test would be; excl. durables)

If we assume that Ricardians reduce durables consumption (one

quarter of consumption):

• 0.65*0.25=0.1625• 0.35*1=0.35

• 0.35+0.1625=0.5125

This is consistent with an MPC of 1 for Non-Ricardians.

Results from other Papers:

• Spilimbergo, Symansky and Schindler (2009),

“Fiscal Multipliers”IMF Staff Position Note 09/11

Research Transfers 1Y Indirect TaxAlEyd-Barell 0.5 (Germany) 0.5FLK (IMF) 0.5 (Euro Area)Zandi (2008) 1.6 (U.S.A.) 1

Comment II

• Given the richness in instruments of this paper, it is important to add tests for government investment:

Ex-Im=Y(I( - C+G+IG+IP

This is the single instrument that enhances Y directly, and is expected to have a

balancing force on B of P deterioration.