Graf v dokumentu a pero FISCAL POLICY III. 3 Fiscal Policy Stabilisation Policy ̶ Aim: to maintain a healthy level of economic growth and minimal price changes; to smooth the economic cycle Stabilisation Policy Monetary Policy Fiscal Policy Three key facts about economic fluctuations 3 Fiscal Policy ̶ Fact 1: Economic fluctuations are irregular and unpredictable ̶ Fact 2: Most macroeconomic quantities fluctuate together ̶ e.g., investment, unemployment, consumption ̶ Fact 3: As output falls, unemployment rises Fiscal policy - concepts and measurements 4 Fiscal Policy Fiscal policy (FP) = set of decisions and rules regarding taxes and public expenditures for purposes of smoothing the fluctuations of economic cycle in order to keep unemployment close to its equilibrium value and avoid the build-up of deflationary and inflationary pressures (Samuelson, 1948) Theoretically inspired by J.M. Keynes. In the end of 20th century theoretical and empirical doubts surfaced about the effectiveness of FP. ̶ Now in many countries the key point of FP is public debt sustainability. Keynesian view: AS – AD model 5 Fiscal Policy ̶ A macroeconomic model that explains price level and output through the relationship between AD and AS ̶ Aggregate demand (AD) = Total amount of demand for goods and services produced in the economy ̶ Combinations of price level and level of output (GDP) ̶ AD slopes downward: a)The Wealth Effect (when prices fall, consumers are wealthier which encourages to spend more) b) b)The Interest-Rate Effect (lower price level reduces the interest rate which encourages greater spending on investment goods) c) c)The Exchange-Rate Effect (lower interest-rate depreciate the real exchange rate which stimulates exports) Keynesian view: AS – AD model 6 Fiscal Policy ̶ Long-run aggregate supply (LRAS) - Determines the quantity of goods and services supplied in the long run. In the long run it depends on labour, capital, natural resources and technology. ̶ Short-run aggregate supply (SRAS) = A combination of price level and level of goods and services supplied in the short run. ̶ SRAS slopes upward: a)The Sticky-Wage Theory (nominal wages are slow to adjust, or are „rigid“ in the short run). b) b)The Sticky-Price Theory (prices of some goods and services are slow to adjust in the short run). c) c)The Misperceptions Theory (lower price level causes misperceptions about relative prices; these misperceptions induce suppliers to respond to the lower price level by decreasing the quantity of goods and services supplied). Keynesian view: AS – AD model 7 Fiscal Policy Economic Fluctuations in AS – AD model 8 Fiscal Policy ̶ Suppose a wave of pessimism in the economy = people lose confidence in the future: Households cut back on their spending Firms put off buying new equipment ̶ Fall in AD A decrease of output A decrease in prices Economic Fluctuations in AS – AD model 9 Fiscal Policy The role of government in AS – AD model 10 Fiscal Policy a) Multiplier ̶ The US government buys $20 billion of goods from Boeing an increase in employment and profits of Boeing. ̶ Workers and firm owners see higher profits, they respond to this increase in income by raising their own spending. ̶ Increase in government spending an increase the demand for the products of many firms in the economy. ̶ Multiplier = the additional shifts in AD that result when expansionary fiscal policy increases consumer spending. 11 Fiscal Policy b) Crowding-out effect 12 Fiscal Policy ̶ An increase in government spending an increase in government deficit an increase in interest rate a decrease in private investment. ̶ The crowding-out effect = the offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending. Crowding-out effect The neoclassical critique ̶ Critique of the multiplier ̶ Full financial crowding-out ̶ Supply rigidity ̶ Fiscal expansion ̶ Rise in the interest rate penalises private investment ̶ Fiscal policy effectiveness is limited in time (data shows that multiplier is close to zero after one year) 14 Fiscal Policy Public budget 15 Fiscal Policy ̶ Public budget = a document that specifies the origin and volume of both income (“receipts”) and intended spending over a certain horizon (usually a year) Public budget ̶ Budget of central government ̶ Budgets of local governments ̶ Functions: allocation, redistribution and stabilisation Public budget 16 Fiscal Policy ̶ Revenue: e.g. an income from direct and indirect taxation, social contributions, income from public assets, income from provision of public services and, possibly, income from disposal of public assets ̶ Spending: e.g. defence, police, justice, education, research, support to the economy, social policy, health, foreign policy, development assistance, etc. Government spending 17 Fiscal Policy Government spending (EU countries) Různé barevné znaky otazníků 22 Fiscal Policy Public budget balance ̶ The fiscal (budgetary) balance = a difference between income and expenditure ̶ Fiscal (budget) surplus - Can be used to pay down public debt or invested ̶ Fiscal (budget) deficit Large deficits were mostly the results of wars (e.g., USA) 22 Fiscal Policy Budget imbalance 23 Fiscal Policy ̶ Budget balance = income – expenditures: surplus (+) or deficit (-) ̶ Central or general government balance ̶ Financial (overall) balance (= net lending); includes net interest payment ̶ Primary balance: excluding net interest payments ̶ Cyclically-adjusted (structural) balance: excluding cyclical balance = FP stance Cyclical and structural components 25 Fiscal Policy Discretionary FP vs. automatic stabilisers 26 Fiscal Policy ̶ Discretionary FP includes changes in government spending and taxation that need specific approval (usually requires legislative action) = a risk of time lags. ̶ Automatic stabilizers increase (decrease) budget deficits during times of recession (booms) without specific new legislation = no time lags: e.g., unemployment insurance program, progressive income taxes Empirical assessment of fiscal multipliers ̶ Effectiveness of fiscal policy depends on the amount of fiscal multiplier ̶ Studies lead to wide range of estimates for fiscal multipliers from less than zero to more than four 27 Fiscal Policy CS: FP during the 2008-2009 crisis 28 Fiscal Policy ̶ Arguments in favor of 2009 stimulus: ̶ Risk of depression (recession with a decline of GDP more than 10 %) ̶ Ineffectiveness of monetary policy (transmission through financial system clogged, in addition to zero band) ̶ Exceptional effectiveness of fiscal policy because of: ̶ General excess supply ̶ Excess savings and flight to safety resulting in ultra-low bond rates ̶ Focus of agents on short-term horizon, credit constraints ̶ Symmetric character of shocks, therefore gains from coordinated action Public debt 29 Fiscal Policy — Public debt = the total of all bonds and other debt owed by a government. Usually, cumulated deficits. — Debt-to-GDP ratio — — Net public debt = gross public debt – value of public assets — — Problem of off-balance-sheet liabilities (ageing, too-big-to fail banks) Debt sustainability 30 Fiscal Policy — Solvency = borrower’s ability to face its commitments. — — Sustainability = a policy course compatible with solvency at all times in the future. — — Sustainability = forward-looking by nature and relies on assumptions on future policy and on the ability of the government to collect/increase taxes. Debt sustainability 31 Fiscal Policy — „Debt can almost always be serviced in some abstract sense, through additional taxation and through the diversion of yet more domestic production to exports to generate the revenue and foreign exchange needed to service the debt. But there is a political and social, and perhaps moral, threshold beyond which policies to force these results become unacceptable.“ J. Boorman (2002) Public debt developments in selected European countries 32 Fiscal Policy How to reduce the debt burden? 1. Fiscal adjustment: cut spending, raise taxes — The most direct but also most difficult way — — As difficult as it is, deficit reduction had been successfully implemented in many European countries. General government spending (% GDP) 33 Fiscal Policy How to reduce the debt burden? 34 Fiscal Policy 2. Raising economic growth — It is possible in medium to long-run — — Factors influencing the rate of growth will be spelt out later (Growth policy) How to reduce the debt burden? 35 Fiscal Policy 3. Monetisation (inflation tax) — Reducing the value of the money base (the central bank’s liability) and of the public debt (the Treasury’s liability) => tax on money and bondholders. — — Inflation must rise unexpectedly and quickly enough. — — A temporary solution: lenders will demand higher interest rates and will be less willing to agree to long-term loans. — — Risk of hyperinflation if the government will be forced to create more money to pay back maturing debt. Monetisation How to reduce the debt burden? 37 Fiscal Policy —4. Default —not rare in Europe before 20th century — — —restructuring: rescheduling, write-downs, interest reductions... — — —coordination: Paris club (public creditors); London club (private creditors); IMF, World Bank. How to reduce the debt burden? 38 Fiscal Policy In practice: — An assistance from financial institution — — Implementation of an adjustment program aimed at restoring debt sustainability — — Debt reduction Political theory of debt 39 Fiscal Policy — The choice of who should pay for the reduction of a high debt is a problem of redistribution. — — Suppose that society can be divided into three groups: rentiers, entrepreneurs and workers. — — Each of these interest groups will seek to avoid the burden of adjustment and shift onto someone else: — Rentiers are opposed to default and inflation tax — — Entrepreneurs are opposed to taxes on capital — — Workers prefer taxes on wealth and capital and the repudiation of debt Rules and principles 40 Fiscal Policy — Fiscal policy is traditionally discretionary — — However, increasing reliance on rules to: • Improve predictability • Address political failures • Improve credibility • Enforce coordination —European Stability and Growth Pact (1997) — —Current discussions in Europe: — Strengthening fiscal discipline — National fiscal rules and institutions More and more rules in the EU 90 80 70 60 50 40 30 20 10 0 1990 1995 2000 Debt rule 2006 Expenditure rule 2008 2011 Revenue rule Budget balance rule 41 Fiscal Policy What is a good rule? 42 Fiscal Policy —The ‘good rule’ according to Kopits and Symansky (1998): — Clear definition, — Transparent public accounts, — Simplicity, — Flexibility – in particular regarding the capacity to react to exogenous shocks, — A rule with possibility of sanctioning non-observance, — Consistency with the other objectives and rules of public policies, — Accompanied by other effective policies. CS: The Stability and Growth Pact 43 Fiscal Policy Two elements: — A preventive arm •A medium term objective •‘Stability’ (Eurozone) and ‘convergence’ (non-Eurozone) programs — Dissuasive arm (‘Excessive Deficit Procedure’) allows for: •Advance warning •Recommendation to correct excessive deficit within given timeframe •Eventual sanctions CS: The Stability and Growth Pact 44 Fiscal Policy — Recent reforms (six-pack, fiscal compact) — Earlier sanctions — — Debt rule 45 Fiscal Policy Reference textbook 46 Fiscal Policy ̶ Benassy-Quéré, A. et al. Economic Policy: Theory and practise. Oxford University Press, 2010. Chap. 3 j0299125