This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper examines the relationship between fiscal policy and the current account, drawing on a larger country sample than in previous studies and using panel regressions, vector autoregressions, and an analysis of large fiscal and external adjustments. On average, a strengthening in the fiscal balance by 1 percentage point of GDP is associated with a current account improvement of 0.2–0.3 percentage point of GDP. This association is as strong in emerging and low-income countries as it is in advanced economies; and significantly higher when output is above potential.
US economic growth turned negative in 2001 following the stock market reversal and the terrorism attacks of September 11. Fiscal policy was shifted through tax cuts, tax reforms, and direct cash payments to individual taxpayers. Some of the important tax reforms were set to expire and revert to their previous form by 2011. This paper will examine those tax policy changes and suggest policy alternatives.
This paper reconsiders the case for the use of fiscal policy based on a “functional finance” approach that advocates the use of fiscal policy to secure high levels of demand in the context of private aggregate demand, which would otherwise be too low. This “functional finance ” view means that any budget deficit should be seen as a response to the perceived excess of private savings over investment at the desired level of economic activity. The paper outlines the “functional finance ” approach and its relationship with fiscal policy. It then considers the three lines of argument that have been advanced against fiscal policy on the grounds of “crowding out. ” These lines are based on the response of interest rates, the supply-side equilibrium, and Ricardian equivalence. The paper advances the view that the arguments, which have been deployed against fiscal policy to the effect that it does not raise the level of economic activity, do not apply when a “functional finance ” view of fiscal policy is adopted. A section on the intertermporal budget constraint considers whether this constraint rules out budget deficits, and concludes that in general it does not.
The global financial crisis has reignited interest in counter-cyclical fiscal policy as a critical instrument to provide immediate economic stimulus. But policy makers are also increasingly interested in how fiscal policy will impact growth and poverty over a longer run horizon, knowing that any quick responses to exogenous shocks also affect income generation and distribution. Those effects are less well known, however, and their dynamics still represent a challenge for many countries. In this book the authors explore methodological advances and new practices for fiscal policy implementation with a particular focus on developing countries. They also attempt to draw preliminary lessons from the global crisis and the still persisting uncertainty about future growth prospects. The crisis has brought into question many economic concepts, policies, and implementation practices that economists supported in previous decades. Counter-cyclical fiscal policy has suddenly returned to prominence worldwide either in conjunction with or in lieu of monetary policy and exchange rate adjustments, as a possible alternative in response to the unexpected and acute shocks that the crisis has brought about. These experiences are providing valuable lessons about the design and effectiveness of fiscal policy measures in developing countries, which is the focus of this volume. Since focusing entirely on the temporary effects of the crisis would mask the bigger challenges underlying the conduct of fiscal policy, particularly in countries where longer term growth patterns remain sluggish or volatile, and poverty and inequality still persist, the authors adopt a broader perspective trying to better understand the dynamics of longer term effects. The purpose of this book is precisely to improve our understanding of the challenges and possible innovative solutions in implementing fiscal policy for growth and welfare purposes, taking into account that crises do occur and will continue occurring, affecting previous growth and inequality paths. The authors present an analysis of some of the trade offs and policy choices that developing countries face, in light of the recent crisis. From expenditure composition to benefit incidence analysis, passing through the difficulties of improving public investment management, the authors consider a whole range of methodological advances and new practices that could enlighten practitioners in designing fiscal policy packages appropriate to the reality of their own countries. A special chapter is dedicated to African countries and a final section highlights some of the remaining topics for future research, together with data and other pertinent issues.
Abstract: The paper provides and empirical characterization of fiscal policy in the euro area and in a group of twenty-two OECD economies over the period from 1970 until 2007. Using the cyclically-adjusted fiscal balance we document that policy in the euro area has been mildly pro-cyclical. The adoption of the common currency and the constraints imposed by the Stability and Growth Pact have not had a large impact on the cyclical behavior of the structural balance. In contrast, over the past ten years US fiscal policy has become highly countercyclical, which was due predominantly to discretionary changes in tax policies. However, the component of the budget due to automatic stabilizers reacts stronger in the euro-area countries than in the US. We also document the primary balance in the OECD economies is more sensitive to output growth rather than to the output gap, which calls into question the common practice of adjusting structural balances by using elasticities with respect to the output gap.