Advanced Macroeconomics II Fiscal Policy Jordi Gal Universitat Pompeu Fabra April 2019
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Advanced Macroeconomics II
Fiscal Policy
Jordi Galí
Universitat Pompeu FabraApril 2019
Dimensions of Fiscal Policy
(a) Expenditures- purchases of goods and services (e.g. administration, public goods)- transfers (e.g. unemployment benefits, pensions)- subsidies (to promote certain activities)- interest expenses (on public debt)
(b) Revenues (taxes)- financing of public expenditures- discourage/punish certain activities
Difference between (a) and (b): deficit/surplus→ issuance of debt/accumulation of assets→ seignorage
Fiscal policy and economic fluctuations→ stabilization tool→ source of fluctuations
Fiscal Policy in the Basic RBC ModelGovernment budget constraint in period t:
Gt + (1 + rt−1)Bgt−1 = τntWtNt + Tt + Bg
t
Household’s budget constraint in period t:
Ct + Bt = (1− τnt )WtNt + (1 + rt−1)Bt−1 + Dt − Tt
Definitions:
Gt: public consumptionBGt : government debt
τnt : labor income taxTt: lump-sum tax (non-distorting)
Modified intratemporal optimality condition:
Un,t + (1− τnt )WtUc,t = 0
for t = 0, 1, 2, ...
Example + log-linear version:
wt = σct + ϕnt − log(1− τnt )
Equilibrium
• Goods marketYt = Ct + Gt
Log-linear version (ignoring constants):
yt = (1− sg)ct + sggt
where sg ≡ G/Y .
• Labor marketσct + ϕnt − log(1− τnt ) = at − αnt + log(1− α)
• Asset marketbt = bgt
ct = Et{ct+1} −1
σ(rt − ρ)
• Equilibrium values (ignoring constants and using log(1− τnt ) ' −τnt ):
nt =(1− sg − σ)at − (1− sg)τnt + σsggt
σ(1− α) + (1− sg)(α + ϕ)
yt =(1 + ϕ)(1− sg)at − (1− α)(1− sg)τnt + (1− α)σsggt
σ(1− α) + (1− sg)(α + ϕ)
ct =(1 + ϕ)at − (1− α)τnt − sg(α + ϕ)gt
σ(1− α) + (1− sg)(α + ϕ)
wt =[σ + ϕ(1− sg)]at + α(1− sg)τnt − ασsggt
σ(1− α) + (1− sg)(α + ϕ)
rt = ρ + σEt{∆ct+1}• Discussion- Fiscal shocks (τnt , gt)- Ricardian equivalence- Countercyclical policies
Empirical Evidence on the Effects of Fiscal Shocks
• The "identification problem"
• Effects of tax changes: Romer & Romer (AER 2010)- "narrative" approach- focus on exogenous tax changes:· legislative action (not automatic)· motivated by:
- need to reduce inherited debt/deficit- long term goals
- estimated equations:
∆yt = α +
K∑k=0
βk∆Tt−k + ut
∆yt = α +
K∑k=0
βk∆Tat−k +
K∑k=0
γk∆Tit−k + ut
Source: Romer and Romer AER 2010
Source: Romer and Romer AER 2010
Source: Romer and Romer AER 2010
• Effects of government purchases: Galí, López-Salido and Vallés (JEEA 2007)- fiscal policy rule:
gt =
K∑k=1
φ′kxt−k + εgt
- macroeconomic effects:
zt =
K∑k=0
βkεgt−k + ut
• Effects of fiscal consolidations: IMF WEO (Oct. 2010)- 15 countries, 1980-2009- 173 fiscal consolidations (aimed at deficit reduction)- estimated equations:
zt = α +
K∑k=0
βkft−k + ut
Source: Galí, López-Salido and Vallés, JEEA 2007
Source: IMF WEO, October 2010
Source: IMF WEO, October 2010
Source: IMF WEO, October 2010
Debt and Deficit Dynamics
• Government budget constraint:Bgt = (1 + rt−1)B
gt−1 + Gt − Tt
• DeficitDEFt ≡ rt−1B
gt−1 + Gt − Tt
• Primary deficitDEF p
t ≡ Gt − Tt• Structural (or cyclically adjusted) deficit
DEF ∗t ≡ rt−1Bgt−1 + G(Y ∗t )− T (Y ∗t )
• Structural primary deficitDEF p,∗
t ≡ G(Y ∗t )− T (Y ∗t )
Debt Dynamics:Bgt = (1 + rt−1)B
gt−1 + DEF p
t
bgt =
(1 + rt−11 + gt
)bgt−1 + def pt
where bgt ≡ Bgt /Yt, def
pt ≡ DEF p
t /Yt and gt ≡ (Yt − Yt−1)/Yt−1
∆bgt =
(rt−1 − gt
1 + gt
)bgt−1 + def pt
Stationary case:
∆bgt =
(r − g1 + g
)bgt−1 + def p
Stability condition:r < g
Steady state debt ratio:
bg =1 + g
g− r defp
Primary Deficit and Debt Dynamics: r<g
11g pt
r g b defg −
−+ +
defp
> > > > > > > > > > > > > > > > < < < < < < <
gtb∆
1gtb −
Primary Deficit and Debt Dynamics: r<g
def p0
> > > > > > > > > > > > > > > > > > > > > < < < <
def p1
gtb∆
1gtb −
11g pt
r g b defg −
−+ +
Primary Deficit and Debt Dynamics: r>g
defp
< < < < < < < < < < < < < < < <
11g pt
r g b defg −
−+ +
gtb∆
1gtb −
> > > > > >
Primary Deficit and Debt Dynamics:
11
( )1
gg ptt
r b g b defg
−−
−+ +
defp
> > > > > > > > > > > > < < < < < < <
gtb∆
1gtb −
> > > > >
1( )gtr b −
Debt Reduction Strategies
• Lower primary deficit (↓ def p)• Higher growth• Financial repression (rg < r)
• Default or debt restructuring (or inflation)• Sale of public assets (privatization)
Short-run vs. permanent fixes.
Fiscal Balance
Debt Ratio
Source: Dallas Fed
Source: IMF Fiscal Monitor, April 2018
Source: IMF Fiscal Monitor, April 2019
Fiscal Rules in Europe
• EU treaty:- "no bailout" clause (Art. 125 TFEU)- "no monetization" clause (Art. 123 TFEU)- limits to deficits and debt ratios (Art. 126 TFEU + EDP Protocol; 3/60);
• Stability and Growth Pact (1997):- "preventive branch": fiscal balance or surplus in the medium-term (stability andconvergence programs)- "corrective branch": excessive deficit procedure (EDP): correction in 2 years, sanc-tions (0.2% of GDP)- 2005 Reform: focus on "structural deficit" (<1% medium term; 0.5% correction peryear); more exceptions.
• Euro-Plus Pact (May 2011):- strengthening of sanctions ("inverted qualified majority")- EDP for excessive debt (>60%); annual correction of 1/20- ceiling on government spending growth (= medium term GDP growth)
• Fiscal Compact (March 2012)- need for national "fiscal stability laws"- maximum structural deficit = 0.5% (1% if deb-ratio is less than 60%)
• October 2012: European Stability Mechanism starts operating• Spain- September 2011: Constitutional amendment (Art 135)- April 2012 "Ley Estabilidad Presupuestaria": structural deficit<0%, 0.8% adjust-ment until 2020
Bailouts- Greece I (May 2010), 110bn- Ireland (November 2010), 85bn- Portugal (May 2011), 78bn- Greece II (March 2012), with restructuring, 130bn- Spain (June 2012), bank capitalization, 100bn- Cyprus (April 2013), 10bn- Greece III (August 2015), 86bn
Euro Area Government Bond Spreads
Source: Dallas Fed
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