02/10/18   1   Economic  Policy  #03   Fiscal  Policy   Fiscal  Policy   •  Concepts  and  measurements   •  Theories:  keynesian  vs.  neo-­‐classical  view   •  FP  during  crisis   •  Public  debt   –  measurement   –  debt  and  deficit  dynamics   –  how  to  reduce  the  debt  burden   •  Fiscal  rules   EP#03  Fiscal  Policy   2   Concepts  and  measurements  #1   Fiscal  policy  (FP)  contains  decisions  regarding  taxes  and   public  spending.     The  noJon  of  FP  usually  refers  to  its  stabiliza(on  func(on  –   changes  in  taxes  and  public  expenditures  for  purposes  of   dampening  the  fluctuaJons  of  the  economic  cycle  –   theoreJcally  inspired  by  J.M.  Keynes.     Toward  the  end  of  the  20th  century  theoreJcal  and   empirical  doubts  surfaced  about  the  effecJveness  of  FP.     Now  in  many  countries  the  key  point  of  FP  is  public  debt   sustainability.       EP#03  Fiscal  Policy   3   02/10/18   2   EP#03  Fiscal  Policy   4   CS.  Public  expenditures  in  various   countries   EP#03  Fiscal  Policy   5  ! 4! Graph 2: General government expenditures (1995 – 2015) Data source: Ministry of Finance, Czech Republic. According to the international comparison, the level of public expenditures in the Czech Republic is rather low – values are below the average of both European Union and Euro Area countries. The Czech Republic – with the average value at 42 % of GDP – reports the second best result behind Slovakia among V4 countries. Moreover, aggregated outlays for the compensation of general government employees are the lowest ones among compared countries. However, the ratio of mandatory expenditures on total general government expenditures is stable and very high, which lowers a possibility of the Czech public finance to react on macroeconomic shocks. Table 1: International comparison – public expenditures (2006 – 2014) Public expenditures / GDP 2006 2007 2008 2009 2010 2011 2012 2013 2014 EU28 45,6 44,9 46,5 50,3 50,0 48,5 49,0 48,6 48,1 EA 46,0 45,3 46,5 50,6 50,5 49,0 49,6 49,5 49,1 Czech Republic 40,8 40,0 40,2 43,6 43,0 42,4 43,8 41,9 42,0 Germany 44,6 42,7 43,5 47,4 47,2 44,6 44,2 44,3 43,9 Hungary 51,9 50,2 48,9 50,8 49,8 49,9 48,7 49,8 50,1 Poland 44,7 43,1 44,4 45,2 45,9 43,9 42,9 42,2 41,8 Slovakia 38,5 36,1 36,7 43,8 42,0 40,6 40,2 41,0 41,8 Note: ESA methodology. Data source: Eurostat. The structure of general government revenues of the Czech Republic is displayed in the graph number 3. The highest volume of revenues (37 %) is generated by social Concepts  and  measurements  #2   Public  budget  is  a  document  that  specifies  the  origin  and   volume  of  both  income  ("receipts")  and  intended  spending   over  a  certain  horizon  (usually  a  year).       •  Receipts:  income  from  direct  and  indirect  taxaJon,  social   contribuJons,  income  from  public  assets  or  from   provision  of  public  services  and,  possibly,  disposal  of   public  assets.   •  Spending:  defense,  police,  jusJce,  educaJon,  research,   support  to  the  economy,  social  policy,  health,  foreign   policy,  development  assistance,  etc.     •  Budgets  for  different  levels  of  government,  ciJes  to   central  government.       EP#03  Fiscal  Policy   6   02/10/18   3   Various  degrees  of  centralizaJon   Fig.  RaJo  of  local  to  general  government  expenses  and  revenues   Various degrees of centralization 55 65 75 ShareinExpenses DK ESP SWZ CAN Ratio of local to general government expenses and revenues (in %) 4 5 15 25 35 45 5 15 25 35 45 55 65 75 ShareinExpenses Sharein Revenues Source: InternationalMonetary Fund,Government Finance Statistics. AUS GR NZ LUX PT BEL AUT IRL FR NOR CZ SWE ICL HUN UK POL IT FIN NL GER Bénassy-Quéré, Economic Policy, 2012-13 Source:  Bénassy-­‐Quéré  (2012)   EP#03  Fiscal  Policy   7   EP#03  Fiscal  Policy   8   Budget  imbalance   Budget  balance  =  income  –  expenditures:  surplus  (+)  or   deficit  (-­‐)   •  Financial  (overall)  balance  (=  net  lending):  including  net   interest  payments   •  Primary  balance:  excluding  net  interest  payments   •  Cyclically-­‐adjusted  (structural)  balance:  excluding   cyclical  balance  =>  FP  stance   •  Underlying  (structural)  fiscal  balance:  cyclically  adjusted   fiscal  deficits  adjusted  for  one-­‐off  operaJons     EP#03  Fiscal  Policy   9   02/10/18   4   CS.  Public  deficits  and  GDP  growth  in   the  Czech  Republic   EP#03  Fiscal  Policy   10   ! 8! followed by “Peltzman effects” and successive increase of expenditures to the same (or higher) level. It was clear and it is clear that politicians, suffering from information asymmetry in comparison with bureaucrats, are not able to lower the public finance intervention spontaneously. That is why the National Economic Council, advisory body to the Czech Government, proposed an implementation of an automatic stabilizer of public finance – the fiscal rule. The rule should respect the “Keynesian” idea of fiscal surpluses during economic booming and possible fiscal deficits during economic downturns. According to the proposal, the budget should be planned with respect to the maximal gap between growth of real GDP and the deficit of public finance at the level 3 percentage points [GDP (%) – deficit (%) = 3 p.p.]. The prognosis of GDP would follow a colloquium of distinguished institutions from public sector (ministries, national bank…), private sector (banks, consultant firms) and academia (universities), both domestic one and foreign one. Graph 5: Fiscal rule proposal Data source: Ministry of Finance and the Czech Statistical Office, Czech Republic. On the graph above, there is a GDP growth (dark curve) and the real deficit of the Czech public finance (red columns). Especially between 2002 and 2007, the fiscal policy was not respecting the economic cycle. The implementation of proposed fiscal rule would lead to the green reality, i.e. to surpluses during upturn of the Czech EP#03  Fiscal  Policy   11   Hospodářská politika 3. Fiskální politika 18 BOX Změny cyklického a strukturálního deficitu v zemích OECD 2008-10 Zdroj: Burda a Wyplosz (2013) Fig.  Changes  from  2008  to  2010  in  actual  and  cyclically  adjusted  budget  balances,   20  OECD  countries  (%  of  GDP)   EP#03  Fiscal  Policy   12   02/10/18   5   Keynesian  view   •  Keynesian  mul?plier     •  LimitaJons:   –  slope  of  supply  curve     –  crowding-­‐out  (interest  rate,  exchange  rate)     –  Ricardian  equivalence     The Keynesian view • Keynesian multiplier • Limitations Price Effect of an expansionary fiscal policy 27 • Limitations – Slope of supply curve – Crowding-out (interest rate, exchange rate) – Ricardian equivalence Production Demand Supply E1 E2 Bénassy-Quéré, Economic Policy, 2012-13 EP#03  Fiscal  Policy   13   Neo-­‐classical  view   •  complete  crowding  out  or  ricardian  equivalence   •  supply  rigidity:  price  flexibility,    raJonal  expectaJons   The Neo-classical view • Complete crowding out (vertical LM curve or flexible exchange rate with perfect capital mobility) or ricardian equivalence price supply 28 equivalence AND/OR • Supply rigidity: price flexibility, rational expectations. production demand Bénassy-Quéré, Economic Policy, 2012-13 The Keynesian view • Keynesian multiplier • Limitations Price Effect of an expansionary fiscal policy 27 • Limitations – Slope of supply curve – Crowding-out (interest rate, exchange rate) – Ricardian equivalence Production Demand Supply E1 E2 Bénassy-Quéré, Economic Policy, 2012-13 EP#03  Fiscal  Policy   14   Supply-­‐side  effects  of  FP   •  Directs:  posiJve  for  (most)  tax  cuts,  negaJve  for  (some)   spending  cuts     •  Permanent  spending  cuts  also  signal  lower  taxes  in  the   future,  thereby  they  have  supply-­‐side  effects     •  ComposiJon  of  fiscal  adjustments  makers   Supply-side effects of fiscal policies • Directs: positive for (most) tax cuts, negative for (some) spending cuts price supply Supply-side effects of a tax cut 31 • Permanent spending cuts also signal lower taxes in the future, thereby they have supply-side effects • Composition of fiscal adjustments matter price output demand supply Bénassy-Quéré, Economic Policy, 2012-13 EP#03  Fiscal  Policy   15   02/10/18   6   DiscreJonary  FP  vs.  automaJc   stabilizers   Discre?onary  FP  includes  changes  in  government  spending   and  taxaJon  that  need  specific  approval  (usually  requires   legislaJve  acJon)  =>  risk  of  Jme  lags.     Automa?c  stabilizers  increase  (decrease)  budget  deficits   during  Jmes  of  recessions  (booms)  without  specific  new   legislaJon  =>  no  Jme  lags:  e.g.  unemployment  insurance   program,  progressive  income  taxes.   EP#03  Fiscal  Policy   16   FP  during  the  2008-­‐09  crisis   •  Arguments  in  favor  of  2009  sJmulus:   –  risk  of  depression   –  ineffecJveness  of  monetary  policy  (transmission  through   financial  system  clogged,  in  addiJon  to  zero  bound)   •  ExcepJonal  effecJveness  of  fiscal  policy  because  of:   –  general  excess  supply   –  excess  savings  and  flight  to  safety  resulJng  in  ultra-­‐low   bond  rates   –  focus  of  agents  on  short-­‐term  horizon,  credit  constraints   –  symmetric  character  of  shocks,  therefore  gains  from   coordinated  acJon   EP#03  Fiscal  Policy   17   to  be  conJnued…   EP#03  Fiscal  Policy   18