Lecture 6 Slides The Effects of Fiscal Changes - Fiscal ...
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LECTURE 6 The Effects of Fiscal Changes:
Fiscal Consolidations
September 28, 2016
Economics 210c/236a Christina Romer Fall 2016 David Romer
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I. OVERVIEW OF THE IMPACT OF FISCAL CONSOLIDATIONS
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How could fiscal contractions be expansionary?
• Wealth effect: With Ricardian consumers, a decrease in G makes people expect lower future taxes. As a result, wealth rises, consumption rises, and labor supply falls. Effects on Y could be positive if prices are sticky.
• Confidence effect: If budget problems are severe, dealing with them may prevent having to take more extreme measures later on. Thus, consolidation can have positive confidence effects on C and I.
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How could fiscal contractions be expansionary? (continued)
• Interest rate effect: Fiscal consolidations may lower risk premium and so lower long rates. This may raise both I and C.
• Coincidence: Budget problems are a symptom of dysfunctional government. Fiscal consolidation is a sign that the government is functioning, and so may be correlated with other measures that are good for growth (i.e. relationship could be present but not causal).
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II. GIAVAZZI AND PAGANO: “CAN SEVERE FISCAL CONTRACTIONS BE EXPANSIONARY? TALES OF TWO
SMALL EUROPEAN COUNTRIES”
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Giavazzi and Pagano’s Regression
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Possible Omitted Variable Bias
• Cyclical adjustment may not fully deal with cyclicality of revenues.
• Countercyclical discretionary policy.
• Other policies (like labor market and trade) may be correlated with fiscal reforms.
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From: Giavazzi and Pagano, “Can Severe Fiscal Contractions be Expansionary?”
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From: Giavazzi and Pagano, “Can Severe Fiscal Contractions be Expansionary?”
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Research Strategy
• Look at Denmark in early 1980s and Ireland in late 1980s.
• Is this a sensible research strategy?
• What might be a more sensible strategy?
• What are they trying to learn from these case studies?
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From: Giavazzi and Pagano, “Can Severe Fiscal Contractions be Expansionary?”
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From: Giavazzi and Pagano, “Can Severe Fiscal Contractions be Expansionary?”
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From: Giavazzi and Pagano, “Can Severe Fiscal Contractions be Expansionary?”
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Alesina and Ardagna’s Measure of Fiscal Consolidations
• A year when the cyclically adjusted primary balance (CAPB) improves by at least 1.5% of GDP.
• Primary balance is the budget position net of interest payments.
• Cyclically-adjust the budget data using simple regression against the unemployment rate. (CBO and OECD uses more detailed methods.)
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From: Alesina and Ardagna, “Large Changes in Fiscal Policy: Taxes Versus Spending”
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III. GUAJARDO, LEIGH, AND PESCATORI: “EXPANSIONARY AUSTERITY: INTERNATIONAL EVIDENCE”
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Possible Problems with the Conventional CAPB Indicator of Fiscal Consolidations
• Something like a stock market boom may raise CAPB and be correlated with other factors raising output.
• Discretionary changes in CAPB may be taken in response to the state of the economy.
• One-time accounting changes may lead to attenuation bias.
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Narrative Approach
• Based on real-time OECD, IMF, and country budget reports and documents.
• 17 countries for 1978–2009.
• Try to determine when there were deliberate fiscal consolidations and whether they were taken in response to the economy.
• Use ex ante estimates of size of actions.
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Evaluation of the Narrative Measure
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From: Guajardo, Leigh, and Pescatori, “Expansionary Austerity”
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Some Examples of Large Differences between the Two Measures
• Germany (1995 and 1996)
• Ireland (2009)
• Denmark (1986)
• Italy (1993)
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From: Guajardo, Leigh, and Pescatori, “Expansionary Austerity”
• Is this test sensible?
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Single-Equation Specification
• Where Yi,t is an outcome in country i in year t and F is the change in CAPB ratio.
• k is set equal to 2 (using annual data).
• Run using both OLS and instrumenting with their narrative measure of fiscal consolidations.
• Would it be more sensible to enter narrative measure directly?
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From: Guajardo, Leigh, and Pescatori, “Expansionary Austerity”
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VAR Specification
• 4 variables (in this order):
• Narrative measure of consolidation shocks.
• Change in CAPB ratio
• Change in log consumption
• Change in log GDP
• 2 lags
• Consider an impulse to equation 1 (narrative measure) such that it results in a contemporaneous rise in CAPB ratio of 1% of GDP.
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For Comparison with CAPB Measure
• Same VAR (in same order):
• Change in CAPB ratio is second equation
• Consider an impulse to equation 2 (change in CAPB ratio) of 1% of GDP.
• Is this sensible? What observations are they using to estimate the IRF to a change in CAPB ratio?
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From: Guajardo, Leigh, and Pescatori, “Expansionary Austerity”
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From: Guajardo, Leigh, and Pescatori, “Expansionary Austerity”
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Calculating a Fiscal Multiplier from a VAR
• Over some horizon, take the cumulative percentage change in GDP and the cumulative change in the fiscal variable (as a percent of GDP) in response to impulse (either in itself or in the instrument).
• Calculate the ratio. In this case −1.57/1.68 = 0.93.
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Extension: Splitting Narrative Measure into Spending-Based and Tax-Based Consolidations
• How do they do it?
• Is this sensible?
• Run a 5-variable VAR
• GLP don’t tell us timing/ordering assumption; might it matter?
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From: IMF, “Will it Hurt? Macroeconomic Effects of Fiscal Consolidation”
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From: Guajardo, Leigh, and Pescatori, “Expansionary Austerity”
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Figure 9 VARs for the Two Types of Exogenous Tax Changes and Real GDP
From: Romer and Romer, “ A New Measure of Fiscal Shocks”
-5.0
-3.0
-1.0
1.0
3.0
5.0
7.0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Per
cent
Quarter
d. Response of GDP to Tax
Using Deficit-Driven Tax Changes
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Extension: Role of Monetary Policy in Explaining Different Results with Spending-Based and
Tax-Based Consolidations
• Add the change in the policy interest rate to the VAR.
• Order it last.
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From: Guajardo, Leigh, and Pescatori, “Expansionary Austerity”
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From: IMF, “Will it Hurt? Macroeconomic Effects of Fiscal Consolidation”
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Extension: Splitting Narrative Measure into High and Low-Sovereign Default Episodes
• How do they do it?
• Is this sensible?
• Run a 5-variable VAR
• What would be an obvious alternative approach?
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From: Guajardo, Leigh, and Pescatori, “Expansionary Austerity”
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IV. ALESINA, FAVERO, AND GIAVAZZI: “THE OUTPUT EFFECT OF FISCAL CONSOLIDATION PLANS”
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A, F, and G’s Focus
• Interested in fiscal plans – multiyear programs of fiscal consolidation.
• Follow WEO’s narrative identification of fiscal consolidations.
• Interested in effects of tax increases versus spending cuts.
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Notation • τ means tax increases, g means government spending
cuts.
• e = τ + g.
• Superscripts: u means unanticipated (announced in t, implemented in t). a means anticipated (announced at least a year before being implemented).
• Subscripts: i countries, t years, j years in advance.
• Example: eai,t,j (j > 0) is consolidation in country i
announced in (by?) year t to be implemented in year t + j.
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A Couple of Their Equations
•
•
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Notation (continued)
• TB means tax-based, EB means expenditure-based:
• Why 0-1 rather than continuous?
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Specification
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Restrictions That Are Imposed
• Only the ϕ’s vary by country.
• The ϕ’s are the same for tax-based and expenditure-based consolidations.
• The impact of anticipated changes does not depend on how long they have been anticipated for.
• The impact of anticipated changes when they are implemented interacts with the current EB-TB dummies.
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Results
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Implications for Selected Countries
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Some Issues
• Why are the estimates so similar across countries?
• Why are the standard errors so small?
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Why Are the Standard Errors So Small?
From: Guajardo et al. (1.65-s.e. confidence intervals); Alesina et al. (1-s.e.)
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Why Are the Standard Errors So Small? (continued)
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Additional Issues
• Does monetary policy explain the differences in the effects of tax-based and expenditure-based plans?
• Final thoughts.
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V. BLANCHARD AND LEIGH: “GROWTH FORECAST ERRORS AND FISCAL MULTIPLIERS”
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Blanchard and Leigh’s Basic Equation
Where:
• ΔYi,t:t+1 is real GDP growth in country i from 2010 to 2011.
• ΔYi,t:t+1|t is the forecast of that GDP growth made in April 2010.
• ΔFi,t:t+1|t is the forecast of the change in the cyclically-adjusted budget surplus in 2010-11 as a percent of potential GDP made in April 2010.
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Blanchard and Leigh’s Basic Results
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Robustness
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Considering Different Time Periods