Appunti di Fiscal Macroeconomics

FISCAL MACROECONOMICS

• GOALS OF BUDGET POLICY

1. PROPER ALLOCATION OF RESOURCES → MARKET FAILURES REQUIRE GVT'S INTERVENTION
2. PROPER DISTRIBUTION OF INCOME
3. ECONOMIC STABILIZATION → OUTPUT GAP SHOULD BE CLOSE TO 0
4. PUBLIC FINANCES SUSTAINABILITY

DEFINITIONS

GOVERNMENT'S BUDGET IDENTITY

NS + IS = R = DF = ΔD

NONINTEREST SPENDING INTEREST SPENDING

INTERTEMPORAL BUDGET CONSTRAINT

THE GOVERNMENT IS SOLVENT IF ITS ASSET (ONLY THE INCOME STREAM OF RESOURCES; WE SUPPOSE THERE ARE NO OTHER PUBLIC REAL OR FINANCIAL ASSETS AND THERE'S NO SEIGNORAGE) IS AT LEAST EQUAL TO ITS DEBT.

PBR = R - NS

Do ➔ PB3 + PB2 = ∑_k=1 (1+i)^-k · PBk

LET'S DEFINE THIS IN RELATION TO GDP:

Do / Yo = Y1/Yo PB3 / Y1 (1+i)^-1 + Y2/Yo PB4 / Y2 (1+i)^-2 + ...

d_o = (1+g)/(1+λ) Ρ1_o + ((1+g)² /(1+i)) Ρ2_o + ... → EXACTLY THE SAME WITH REAL RATES

λ = i - g / 1+g

d_o = Ρ0 / (1+2) + Ρ2 / ((1+2)²) + ... → d_o = ∑_k=1 (1+λ)^-k Ρ_ko

NO-PONZI-GAME CONDITION

lim_t→∞ (1+r)^-t D_t = 0→ Public debt can increase forever, but at a lower rate than interest rate; sooner or later the government will need to run primary surpluses!

OR

lim_t→∞ (1+λ)^-t d_t = 0→ d_t must increase at a lower rate than λ

IBC and NPG are EQUIVALENT!

• i > g → If debt ratio is stable, IBC/NPG are always met (growth rate of debt = g < i)

  IBC/NPG may hold even with a rising debt ratio however the primary balance ratio should rise forever (IBC); but d_t is bounded (it obviously cannot go above 100% of GDP)

• i < g → The stability of the debt ratio does not imply that IBC/NPG are met (there can be permanent primary deficits); GDP acts as collateral (for many economists this is enough, even without IBC/NPG)

PUBLIC DEBT DYNAMICS EQUATION

D_t = D_t-1 + i D_t-1 - PB_t

d_t = D_t-1 / Y_t + i D_t-1 / Y_t - pb_t

d_t = D_t-1 / Y_t-1(1+g) + i D_t-1 / Y_t-1(1+g) - pb_t

d_t = d_t-1 / (1+g) + i d_t-1 / (1+g) - pb_t

1) DEBT RATIO

r_t GAP r_t+4 (STABILIZING d_t)

OR S1 INDICATOR (EU COMM.)

S1 = 1_do = d₁^‿

SHORT TERM FACTORS AFFECTING r_t

• ANNOUNCED POLICY CHANGES
• CYCLICAL EFFECTS
• ONE-OFF FACTORS

LONG ↔ PENSION AND HEALTH CARE SPENDING

• DEMOGRAPHICS
• REVENUES FROM EXHAUSTIBLE RESOURCE

S2 INDICATOR (EU COMM.)

l_do = ∑ (1 + λ)^-t (N_do + S2)_t=d

OR

S2 = 1_do − ∑ (1 + λ)^-t N_do^t=d

HOW MUCH WE SHOULD ADD IN DEEPER TRY TO r_t TO MEET IDC

DEBT CHARACTERISTICS

• DEBT MATURITY
• CURRENCY COMPOSITION
• COMPOSITION OF INVESTOR’s BASE

2) CONTRACTUAL OBLIGATIONS (PPPs)

• FINANCIAL SECTOR SUPPORT
• LONG-LASTING MACRO SHOCKS
• POLICY CHANGES AND POLITICAL SHOCKS

3) OVERALL HEALTH OF THE ECONOMY (PRIVATE DEBT, EXTERNAL DEBT)

• CHANGES IN MARKET MOOD

CYCLICALLY ADJUSTED AND STRUCTURAL DEFICITS

OUTPUT GAP

^{2 − Y}/_Y^P

POTENTIAL GDP: NON INFLATIONARY, FULL-EMPLOYMENT OUTPUT

ELASTICITY OF REVENUES TO GDP:

n = dln(R)_{− dln(y)}

SOLVING THE DIFF. EQUATION FOR LEVELS

ln(R/ÿ) = μ − ln(ÿ) + K

- THIS APPROACHES ASSUME THAT FUTURE FISCAL STANCE IS FULLY DESCRIBED BY PAST BEHAVIOUR.

- IN THE SECOND MODEL, ALL COEFFICIENTS ARE IMPOSED EQUAL ACROSS COUNTRIES WITH THE EXCEPTION OF THE INTERCEPT (FIXED EFFECTS). SOME COUNTRIES WILL THUS HAVE ARBITRARY d₀.

- THERE ARE VERY FEW OBSERVATIONS OF HIGH DEBT COUNTRIES.

NONFINANCIAL (ENTITLEMENT) DEBT

PROMISES OF FUTURE PAYMENTS NOT REPRESENTED BY BONDS OR LOANS

• HEALTHCARE
• PENSIONS

NEW IDC: B_t EXCLUDING ENTITLEMENT EXPENDITURES

d₀ = ∑_k=1^∞ (1+λ)^-k(B_t+k - B_t+k-1 - IA_t+k)

↑ ENTITLEMENT EXPENDITURES (LEVEL IN YEAR 1 PLUS INCREASES)

d₀ + ∑_k=1^∞ (1+λ)^-k IA_t+k = d₀ + d₀ = ∑_k=1^∞(1+λ)^-k(IA_t+k - IA_t+k-1)

• FINANCIAL NONFINANCIAL DEBT DEBT

IS ENTITLEMENT DEBT RELEVANT FOR ROLLOVER CRISES? ECONOMETRIC EVIDENCE SAYS IT DOESN'T SEEM SO.

• WHY?
• NONFINANCIAL PAGE EASILY EXPLAINED, MAYBE RESEARCHERS DIDN'T USE THIS DATA
• THIS DISAPPEARS FROM MARKETS, ONLY THESE. ONLY PROJECTIONS FOR ENTITLEMENT SPENDING ARE DIFFICULT TO MAKE (THEY ARE VERY LONGTERM), RESULT ASSUMPTION - SENSITIVE
• TO ROLL-OVER, AND IT CAN'T BE SOLD ON SECONDARY MARKETS CAUSING “SPREAD CRISES”.

TRENDS IN ENTITLEMENT SPENDING

BIG INCREASE IN G7, ESPECIALLY IN 1960-1980, MAINLY DRIVEN BY HEALTHCARE AND PENSIONS

Data in Public Finance

Public Sector

• Central Government
• Sub-national Governments
• Public Enterprises^*

We look at consolidated accounts.

• ^* Included in general GVT's accounts if revenues come primarily from the government.
• ^** Usually not included, so bonds held by the CB are regarded as regular market debt.

• Flows vs Stocks
• Accrual basis (ESA₉₅) – Economically more correct, data easier to find, more correlations with debt data.
• Cash basis
• Commitment basis

• Net Debt vs Gross Debt
• Only highly liquid assets are netted out.
• Coins included.

Stock-flow adjustment = ΔG_d - DEF

(3% GDP Italy 2018-20) Sizeable sometimes!

• Bonds issued below par value
• FX fluctuations
• Acquisition or sale of real or financial assets
• Indexed bonds
• Differences in accounting methods
• Cost of derivatives

1. The dodger a country, the more difficult to find data for sub-national GVT.
2. Accrual basis = AE, Cash basis = EM, LIC + a lot of delayed payments.
3. The IMF forecasts the macro assumptions of the GVT's projections often.

BUILDINGS HAVE A CULTURAL VALUE.

• FRAGMENTATION OF OWNERSHIP

E.G. LOCAL PUBLIC UTILITIES.

• RISK OF FIRE SALE

- PRIVATIZATIONS PER YEAR IN ITALY (2014-17) ≈ 0.25% OF GDP

N.B.: UNLIKE FOR A PRIVATE ENTERPRISE, ACQUISITION OF REAL ASSETS BY THE GVT IS RECORDED AS A COST ITEM (ESA 2010). THE IMPACTS ON PRIVATIZATION ARE OBVIOUSLY ONE-OFF.OFTEN GREY TRY TO DO ACCOUNTING TRICKS WITH ‘FAKE PRIVATIZATION’(SALE AND LEASE BACK OF BUILDINGS AND SALE OF ASSETS TO PUBLIC ENTITIES OUTSIDE GENERAL GVT STATISTICS)

FINANCIAL REPRESSION

FORCING INVESTORS TO BUY PUBLIC SECURITIES AT A LOWER INTEREST RATE THAN THE ONE THAT WOULD PREVAIL IN A COMPETITIVE MARKET. IT WAS QUITE COMMON UNTIL 30 YEARS AGO.

HOW IS IT DONE?

• PUBLIC OWNERSHIP

OF SOME BANKS

CONSTRAINTS ON BANKS: CEILINGS ON INTEREST RATES (ESPECIALLY TREASURY BONDS) AND GVT RECOUPTION ON DEPOSIT RATES

• IMPRISONMENT OF INVESTORS COMMUNITY WITHIN NATIONAL BOUNDARIES!CAPITAL ACCOUNT RESTRICTIONS, CEILING ON BANK LOANS TO THE PRIVATE SECTOR,PORTFOLIO CONSTRAINTS FOR FINANCIAL INSTITUTIONS

“FINANCIAL REPRESSION TAX” (NEGATIVE ω) ≈ 10-40% OF TAX REVENUES IN THE POST-WAR ERA (2-3% OF GDP FOR USA AND UK)

FRIT: D - r

IT IS STILL COMMON IN EM, + N = X ₀

IT HAS ACCIDENTALLY COME BACK IN FASHION IN AE DUE TO INCREASED CAPITAL REQUIREMENTS, AND ALSO THE FACT THAT THE LIQUIDITY PROVIDED BY THE CB TO BANKS STAYS IDLE IN CB DEPOSITS AND DOES NOT DRIVE UP INFLATION. BANK EQUITY AT THE MOMENT, IS PERCEIVED TO BE RISKY (ALSO, SUPRANATIONAL MONETARY POLICIES REDUCE PROFIT MARGIN FOR BANKS, MAKING THEIR SHARE EVEN LESS ATTRACTIVE).