Transcript From CAB to CAAB

From CAB to CAAB?
Correcting indicators of structural fiscal
positions for current account imbalances
Julia Lendvai
Laurent Moulin
Alessandro Turrini
DG ECFIN, European Commission
Motivation



Before the crisis, a number of EU countries have witnessed absorption
booms and growing current account deficits as a result of falling risk
premia and rapid financial integration.
At the same time, fiscal policy in those same countries has not been
leaning against the wind effectively so as to contain boom-bust
dynamics.
This analysis
– shows that standard approaches for adjusting budget balances for the
cycle could miss part of the temporary revenues accruing during
absorption booms
– Illustrates a methodology to correct government budget balances for
temporary elements linked both to output cyclicality and to absorption
booms (CAAB)
– Uses DSGE models to assess the implications of tageting the CAAB during
absorption booms for output stabilisation and the accumulation of
external imbalances
Absorption booms, current account,
fiscal policy
Figure. Developments in macroeconomic and fiscal variables during and after absorption booms
Real GDP growth
Absorption (percent of GDP)
6
115
T is the peak year of the absorption boom
5
4
Government balance (percent of GDP)
0
T-5
112
109
Current Acc. balance (percent of GDP)
0
T-4
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
T-5
-2
-1
-4
-2
-6
-3
-8
-4
-10
-5
-12
-6
-14
-7
T-4
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
3
2
106
1
103
0
-1
100
T-5
T-4
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
T-5
T-4
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
-2
Gov. primary balance (pct of GDP)
Cyclically adjusted balance (pct of GDP)
2
0
1
-1
Gov. gross debt (percent of GDP)
50
45
-2
0
Total government revenue (pct of GDP)
40
39
40
T-5
T-4
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
-1
-3
35
-4
38
-2
30
-5
-3
-6
25
T-5
-4
T-4
Indirect taxes (percent of GDP)
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
37
T-5
Direct taxes (percent of GDP)
T-4
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
T-5
T-4
Social contributions (percent of GDP)
14,0
10,0
12
13,5
9,5
12
13,0
9,0
11
12,5
8,5
11
12,0
8,0
10
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
Elasticity of tax revenue to GDP
1,3
1,2
1,1
1,0
0,9
0,8
T-5
T-4
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
T-5
T-4
Total gov. expenditure (pct of GDP)
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
0,7
T-5
Social benefits (percent of GDP)
T-4
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
T-5
Final gov consumption (pct of GDP)
16
23
6
44
15
22
5
43
14
21
4
42
13
20
3
41
12
19
2
40
11
18
1
39
10
17
T-4
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
T-5
T-4
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
Gross capital formation (pct of GDP)
45
T-5
T-4
0
T-5
T-4
T-3
T-2
T-1
T
T+1 T+2 T+3 T+4 T+5
T-5
T-4
T-3
T-2
T-1
T
T+1
T+2
T+3
T+4
T+5
Absorptiom booms, current
account, fiscal policy

Some stylised facts:
– Current accounts deteriorate during absorption booms,
improving afterwards;
– Government budget balance improves during the boom,
falling afterwards;
– CAB broadly constant during the boom, falling afterwards;
– Strong growth of indirect revenues/GDP during the boom ;
– Apparent revenue elasticities growing during the boom,
falling afterwaeds
Linking current accounts and structural
indicators of fiscal policy (I)



CAB approach assumes that revenues are linked to
output
While this is the case for direct taxes, indirect taxes
are levied on imports but not on exports, i.e., they
are linked to absorption
For the above reason, and since output and
absorption are imperfectly correlated, the CAB may
miss temporary cyclical components of the budget
during absorption booms and busts
Linking current accounts and structural
indicators of fiscal policy (II)



The CAB is built on a well-known benchmark for
computing structural revenues and expenditures,
i.e., output equal to potential
An equally obvious candidate is not available for
defining a benchmark for absorption
Approach taken: link benchmarks for absorption to
benchmarks for current accounts. Current account
balances in line with fundamentals (“current
account norms”).
From CAB to CAAB
CABt = (b/y)t – λ ygapt
CAABt = (b/y)t – βt ygapt – γt agapt,
βt = λt -γt.
agapt = [(at – a*t)/y*t],
a*t = y*t – ca*t + itt.
From CAB to CAAB

The current account norm ca* is estimated following the approach
developed in Chinn and Prasad (2004) and by the IMF CGER (Lee et
al., 2008).

Prediction from pooled cross-section/time series regressions

Sample: 60 advanced and emerging economies, 1970-2010

Specification:
–
–
–
–
–
–
General government budget balance/GDP ratio (+)
Old-age dependency ratio (-)
Real GDP per capita at PPP (+)
Real GDP per capita growth (-)
Net foreign asset/GDP ratio (+)
Oil balance (+)
Does CAB or CAAB
make a difference? (I)
Difference between CAAB and CAB,
selected euro-area countries
(percent of GDP)
1.5
1
0.5
-1.5
-2
DE
EL
PT
ES
AT
09
08
-1
20
07
20
06
20
05
20
04
20
03
20
02
20
01
20
00
20
99
20
98
19
19
97
96
19
19
-0.5
19
95
0
Does CAB or CAAB
make a difference? (II)
Difference between CAAB and CAB
for selected New Member States
(percent of GDP)
2
1
0
-1
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
-2
-3
-4
-5
BG
EE
LV
LT
RO
Does CAB or CAAB make a
difference? (III)
Difference between CAAB and CAB
for selected New Member States
NFA-stabilisation approach
(percent of GDP)
1,5
1
0,5
0
-0,5
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
-1
-1,5
-2
-2,5
-3
-3,5
BG
EE
LV
LT
RO
Does targeting the CAAB
make a difference? (I)


DSGE model simulations help assessing the extent to
which targeting the CAAB rather than the CAB can make
a difference for fiscal prudence and preventing
imbalances
Simulation with QUEST III
– Model set up


Small open economy, fixed XXR
Calibrated to average Baltic economy
– Shocks



A): Baseline: 500 bp. reduction in risk premium in 2001
B): A)+ CAB=0 since 2005 (max 4% GDP)
C): A) + CAAB==0 since 2004 (max 7% GDP)
Does targeting the CAAB
make a difference? (II)
Targeting CAB or CAAB balance during absorption booms: DSGE
model simulations
Budget Balance
(% of GDP deviation from base scenario)
GDP (% deviation from steady state)
Consolidation
targeting CAAB
20
00
A
20
01
A
20
00
A
20
01
A
20
02
A
20
03
A
20
04
A
20
05
A
20
06
A
20
07
A
Consolidation
targeting CAAB
Terms of Trade
(% deviation from steady state)
CPI (% deviation from steady state)
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
2.5
Base scenario
2
Base scenario
1.5
Consolidation
targeting CAB
Consolidation
targeting CAAB
Consolidation
targeting CAB
1
Consolidation
targeting CAAB
0.5
20
00
A
20
01
A
20
02
A
20
03
A
20
04
A
20
05
A
20
06
A
20
07
A
20
00
A
20
01
A
20
02
A
20
03
A
20
04
A
20
05
A
20
06
A
20
07
A
0
NFA / GDP (%)
Current Account / GDP (%)
-20
-6
Consolidation
targeting CAB
-30
-8
Consolidation
targeting CAAB
-50
-40
-10
-60
-12
-70
-14
-80
20
06
A
20
07
A
-10
20
04
A
20
05
A
Base scenario
20
00
A
20
01
A
20
06
A
20
07
A
20
02
A
20
03
A
20
04
A
20
05
A
20
00
A
20
01
A
-4
20
02
A
20
03
A
0
0
-2
20
06
A
20
07
A
Consolidation
targeting CAB
Consolidation
targeting CAB
20
04
A
20
05
A
Base scenario
8
7
6
5
4
3
2
1
0
20
02
A
20
03
A
3.5
3
2.5
2
1.5
1
0.5
0
Base scenario
Consolidation
targeting CAB
Consolidation
targeting CAAB
Concluding remarks



The standard EU method for adjusting budget balances during the
cycle may miss some temporary revenue components during
absorption boom and busts
A relatively straightforward modification of the CAB that also takes
into account the fact indirect taxes are linked to absorption (CAAB)
could be a useful counter-check in assessing the structural fiscal
position of countries
Taking into account the link between temporary revenues and
absorption in constructing indicators for structural fiscal balances
would contribute to
– Fiscal prudence during absorption booms
– strengthening the contribution of the fiscal balance in preventing external
imbalances