Fiscal Alchemy?
An International Perspective
Jeffrey Frankel
Seminar on Macroeconomic Policy
Harvard Economics Department
April 28, 2015
“Fiscal alchemy”?
• Eric Leeper had it backwards:
– "Monetary science, fiscal alchemy" (Jackson Hole, 2010).
• It should be Monetary alchemy, fiscal science:
• Under post-2008 conditions, we could have been
more confident that countercyclical fiscal policy
would have speeded the recovery than
countercyclical monetary policy.
Fiscal multipliers are relatively high under post2008 conditions: low output, low inflation, & ZLB.
• Martin Feldstein (2009) “Rethinking the Role of Fiscal Policy,” American Economic Review 99, 2, 556-9:
“Some of the past problems in using fiscal policy to stimulate demand may be less of an
impediment in the current circumstances.”
• Econometric studies
•
Aizenman, Joshua, & Yothin Jinjarik (2012), “The Fiscal Stimulus of 2009-10: Trade Openness, Fiscal Space and Exchange Rate Adjustment,” in NBER
International Seminar on Macroeconomics 2011, J.Frankel and C.Pissarides, eds. (University of Chicago Press).
•
Auerbach, Alan, & Yuriy Gorodnichenko (2012a), "Measuring the Output Responses to Fiscal Policy," American Economic Journal: Economic Policy,
4(2), 1-27, May.
•
Auerbach, Alan, & Yuriy Gorodnichenko (2012b), "Fiscal Multipliers in Recession and Expansion," in Alberto Alesina and Francesco Giavazzi
(eds.) Fiscal Policy after the Financial Crisis (University of Chicago Press).
•
Baum, Anja, & Gerritt Koester (2011), “The Impact of Fiscal Policy on Economic Activity Over the Business Cycle - Evidence from a Threshold VAR Analysis”
Deutsche Bundesbank, Disc. Paper Series 1: Economic Studies, 3.
•
•
•
•
Baum, Anja, Marcos Poplawski-Ribeiro & Anke Weber (2012), "Fiscal Multipliers and the State of the Economy," IMF Working Paper 12/286.
Blanchard, Olivier, and Daniel Leigh (2013), “ Growth forecast errors and fiscal multipliers,” American Economic Review, 103(3) May.
Fazzari, Steven, James Morley, & Irina Panovska (2012), “State-Dependent Effects of Fiscal Policy”, Studies in Nonlinear Dynamics & Econometrics .
Ilzetzki, Ethan, Enrique Mendoza & Carlos Vegh (2013), "How Big (Small?) are Fiscal Multipliers?" Journal of Monetary Economics.
• But consider country cases below.
– Japan.
– Euroland.
– Emerging markets.
Monetary policy is of course
relatively less powerful at Zero Lower Bound.
• even though it is still worth doing,
via channels other than short-term interest rate:
– Exchange rate
• if particular countries need more stimulus than others;
– Expected inflation;
– Long-term bonds, equities, and real estate.
• Coordination of monetary policy is not
especially needed, despite “currency wars.”
How had Keynesian fiscal policy been discredited?
• Not lack of knowledge,
• nor lack of effectiveness.
• Rather:
political failure to pursue stimulus only counter-cyclically.
• But that is no excuse for politicians who pursue fiscal
policy pro-cyclically,
• as was the norm in developing countries before 2000,
• and the pattern among some in advanced countries since 2000.
• “Secular stagnation” is not needed to explain recent
slow growth; pro-cyclical fiscal policy can do it.
Recent cases
1) Japan
2) Euroland
3) Emerging Market economies
(Case 1) Japan
• The three arrows of Abenomics
– Monetary stimulus (2% inflation target + QQE)
– Fiscal policy (?)
– Structural reform (?)
Japan’s monetary easing (QQE)
raised the exchange rate (Yen/$) and stock market
HR dissolved,
Nov. 2012 =>
“Abenomics”
“Outlook 2014 - Recovery on a shaky footing,” Special , Economic Research Dept., Rabobank November 13, 2013, https://economics.rabobank.com/publications/2013/november/outlook-2014-recovery-on-a-shaky-footing/
But effects on growth (& inflation) were disappointing.
• Because the 2nd & 3rd arrows haven’t been fired?
• I’d say the 2nd was fired in the wrong direction:
– Abe went through with the scheduled increase
in the consumption tax taking effect April 1, 2014,
– from 5% to 8%.
– As many had warned, Japan went back into recession,
i.e., growth turned negative for next two quarters.
Abenomics seemed to boost growth, at first.
But Japan went back into recession in 2014 Q2,
perhaps because of a big increase in the consumption tax.
Nov. 2012 =>
“Abenomics”
April 2014 =>
Consumption tax
ITF220 - Professor J.Frankel
Can Japan address its serious long-term debt problem,
while avoiding contraction in the short term?
Proposal:
Replace the immediate discrete rise in the consumption tax
with a pre-announced committed gradual path of increases,
e.g., 0.25% every year until reaching 10%.
Advantages:
• If the path is credible, it will preclude a loss of confidence
in the sustainability of Japan’s debt.
• The short-term impact will not be contractionary.
• Indeed, it will help generate expectations of inflation.
(Case 2) Euroland
• The three arrows of Mario Draghi
(Jackson Hole 8/22/2014)
– Monetary stimulus:
• QE, launched Jan. 22, 2015.
– Fiscal stimulus:
• Those with space should spend.
– Structural reform:
• esp. labor markets.
When the ECB launched QE in 2015,
the euro depreciated immediately
(2% in 3 hours)
But fiscal policy was pro-cyclical,
especially in Greece:
expansion in 2000-08, contraction in 2010-14
Source:
IMF, 2011.
I. Diwan,
PED401,
Oct. 2011
14
EU fiscal austerity has been contractionary.
Source:
Paul
Krugman,
May 10, 2012.
What about the critique that fiscal policy responded endogenously
(and negatively) to the magnitude of the countries’ difficulties?
The bigger the fiscal contraction, the bigger the GDP loss
relative to what had been officially forecast
=> true multipliers > than multipliers that IMF had been using.
Europe: Growth Forecast Errors vs. Fiscal Consolidation Forecasts
Source: Olivier
Blanchard &
Daniel Leigh,
2014, “Learning
about Fiscal
Multipliers
from Growth
Forecast Errors,”
fig.1, IMF Economic
Review 62, 179–212
Note: Figure plots forecast error for real GDP growth in 2010 and 2011 relative to forecasts made in the spring
of 2010 on forecasts of fiscal consolidation for 2010 and 2011 made in spring of year 2010; and regression line.
In 2015 periphery economies remain weak.
Source: Jeffrey Anderson and Jessica Stallings, Feb. 13, 2014, “Euro Area Periphery: Crisis Eased But Not Over,” Institute of International Finance, Chart 3
Fiscal austerity hasn’t even achieved the supposed goal of restoring
debt sustainability: debt/GDP ratios continued to rise sharply.
Declining GDP outweighed progress on reduction of budget deficits.
200
Public Debt (% GDP)
180
160
France
Germany
Greece
Ireland
Italy
Portugal
140
120
100
80
60
40
Spain
20
0
.
From Rémi Bourgeot, Fondation Robert Schuman
Data source: IMF WEO (October 2014).
(Case 3) Emerging Markets
Fiscal policy in some EMs
• turned from pro-cyclical to countercyclical after 2000,
– -- e.g., Chile, India, Malaysia, Korea, China, Botswana --
• taking advantage of 2002-08 boom to strengthen their budgets,
• and so making “fiscal space” to moderate the 2008-09 recession.
= the opposite from some Industrialized Countries.
Some major EMs are more vulnerable to the next shock
– because they have backslid on cyclicality since 2010,
• e.g., Brazil, India, Thailand.
– or never did graduate from pro-cyclicality at all,
• e.g., Argentina, Venezuela.
Correlations between Gov.t Spending & GDP
1960-1999
procyclical
Adapted from Kaminsky, Reinhart & Vegh (2004)
Pro-cyclical spending
countercyclical
Countercyclical
spending
G always used to be pro-cyclical
20
for most developing countries.
procyclical
Correlations between Government spending & GDP
2000-2009
Frankel, Vegh & Vuletin (JDE, 2013)
countercyclical
In the last decade,
about 1/3 developing countries
switched to countercyclical fiscal policy:
21
Negative correlation of G & GDP.
Appendices
• (1) Japan’s Abenomics
• (2) Euroland
• (3) Which Emerging Market countries
achieved fiscal counter-cyclicality?
– and how?
(1) Japan’s monetary easing weakened the yen, 2012-13
House of Representatives dissolved,
Nov. 2012 => “Abenomics”
Takatoshi Ito, “Abenomics: Progress, prospects and how the 2020 Tokyo Olympics can help solve Japan’s debt problem”
ADB Institute DEC.30, 2013 http://www.asiapathways-adbi.org/2013/12/abenomics-progress-prospects-and-how-the-2020-tokyo-olympics-can-help-solve-japans-debt-problem/
(2)Unemployment in the euro periphery remains high
Source: Jeffrey Anderson and Jessica Stallings, Feb. 13, 2014 , “Euro Area Periphery: Crisis Eased But Not Over,” Institute of International Finance, Chart 1
(3) Emerging Markets
Adapted from Frankel, Vegh & Vuletin (JDE, 2013)
In the decade 2000-2009,
about 1/3 developing countries
switched to countercyclical fiscal policy:
Negative correlation of G & GDP.
DEVELOPING:
43% (or 32 out of 75) countercyclical. The figure was 17% (or 13 out of 75) in 1960-1999.
INDUSTRIAL:
86% (or 18 out of 21) countercyclical. The figure was 80% (or 16 out of 20) in 1960-1999.
Latest update of Correlation (G, GDP):
Back-sliding among some countries, 2010-2014.
Thanks to Guillermo Vuletin
DEVELOPING: 37% (or 29 out of 76) pursue counter-cyclical fiscal policy.
INDUSTRIAL: 63% (or 12 out of 19) pursue counter-cyclical fiscal policy.
The correlation for 2000-09 vs. 2010-14
Who achieves counter-cyclical fiscal policy?
Countries with “good institutions”
IQ
”On Graduation from Fiscal Procyclicality,”
Frankel, Végh & Vuletin; J.Dev.Economics, 2013.
29
The quality of institutions varies,
not just across countries, but also across time.
1984-2009
Worsened institutions;
More-cyclical spending.
Improved institutions;
Less-cyclical spending.
Good institutions;
Countercyclical spending
Frankel, Végh
& Vuletin,2013.
30
How can countries avoid pro-cyclical fiscal policy?
• What are “good institutions,” exactly?
• Rules?
– Budget deficit ceilings (SGP) or debt brakes?
• Have been tried many times. Usually fail.
– Rules for cyclically adjusted budgets?
• Countries are more likely to be able to stick with them. But…
• An under-explored problem:
– Over-optimism in official forecasts
• of GDP growth rates & budgets.
• Frankel & Schreger (2013), "Over-optimistic Official Forecasts
and Fiscal Rules in the Eurozone," Weltwirtschaftliches Archiv.
• Frankel (2011), "Over-optimism in Forecasts by Official Budget
Agencies and Its Implications," Oxford Review of Economic Policy.
31
Countries with Balanced Budget Rules
frequently violate them.
BBR: Balanced
Budget Rules
DR: Debt Rules
ER: Expenditure
Rules
Compliance
< 50%
International Monetary Fund, 2014
To expect countries to comply with the rules during
recessions is particularly unrealistic
(and not even necessarily desirable).
Bad times: years when output gap < 0
International Monetary Fund, 2014
US official projections were over-optimistic on average.
F & Schreger, 2013
34
Greek official forecasts were always over-optimistic.
Data from Greece’s Stability and Convergence Programs.
F & Schreger, 2013
35
German forecasts were also usually too optimistic.
36
Most European official forecasts have been over-optimistic.
Figure 1 (F&S, 2013):
Mean 1-year ahead budget forecast errors, European Countries,
Full Sample Period
For 17 Europeans, the bias is even higher than others, averaging:
0.5% at the 1-year horizon,
1.3% at the 2-year horizon,
2.4% at the 3-year horizon
37
Figure 2 (F&S, 2013):
Mean 2-year ahead budget forecast errors, European Countries,
Full Sample Period
38
The case of Chile
• 1st rule – Governments
must set a budget target,
• 2nd rule – The target is structural:
Deficits allowed only to the extent that
– (1) output falls short of trend, in a recession,
– (2) or the price of copper is below its trend.
• 3rd rule – The trends are projected by 2 panels
of independent experts, outside the political process.
– Result: Chile avoided the pattern of 32 other governments,
• where forecasts in booms were biased toward optimism.
Frankel (2013), “A Solution to Fiscal Procyclicality: The Structural Budget Institutions Pioneered by Chile,”
in Fiscal Policy and Macroeconomic Performance, edited by Luis Céspedes & Jordi Gali (Central Bank of Chile).
39
Chile’s official forecasts have not been over-optimistic.
40