Transcript Macroeconomic Policy in Countries with Natural Resource Wealth

Macroeconomic Policy
in Countries with Natural Resource Wealth
Jeffrey Frankel
Harpel Professor of Capital Formation & Growth
Leading Economic Growth Program
February 14, 2013
In 2008, the government of Chilean President Bachelet
& her Fin.Min. Velasco ranked very low in public opinion polls.
By late 2009, they were the most popular in 20 years. Why?
Evolution of approval and disapproval of four Chilean presidents
Presidents Patricio Aylwin, Eduardo Frei, Ricardo Lagos and Michelle Bachelet
Data: CEP, Encuesta Nacional de Opinion Publica, October 2009, www.cepchile.cl.
Source: Engel et al (2011).
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Commodity exporters face extra
volatility in their terms of trade
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Choices of macroeconomic policies &
institutions can help manage the volatility.
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Too often, historically, they have exacerbated it:
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Pro-cyclical macroeconomics
capital flows, money, credit;
 currency policy; relative price of nontraded goods;
 and fiscal policy.
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Pro-cyclical capital flows
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According to intertemporal optimization theory,
capital flows should be countercyclical:
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In practice, it does not always work this way.
Capital flows are more procyclical than countercyclical.
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net capital inflows when exports are doing badly
and net capital outflows when exports do well.
Gavin, Hausmann, Perotti & Talvi (1996); Kaminsky, Reinhart & Vegh
(2005); Reinhart & Reinhart (2009); and Mendoza & Terrones (2008).
Theories to explain this involve
capital market imperfections,
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e.g., asymmetric information
or the need for collateral.
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Pro-cyclical monetary policy
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If the exchange rate is fixed,
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surpluses during commodity booms lead to:
Rising reserves
 Excessive money & credit
 Excess demand for goods; overheating
 Inflation
 Asset bubbles.
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Example:
Saudi Arabia & UAE during recent oil boom.
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Macro effects of commodity boom
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Inflation shows up especially in
nontraded goods & services
like construction.
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Procyclical fiscal policy
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Fiscal policy has historically tended
to be procyclical in developing countries
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especially among commodity exporters:
Cuddington (1989), Tornell & Lane (1999), Kaminsky, Reinhart &
Vegh (2004), Talvi & Végh (2005), Alesina, Campante & Tabellini
(2008), Mendoza & Oviedo (2006), Ilzetski & Vegh (2008), Medas
& Zakharova (2009), Gavin & Perotti (1997).
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Correlation of income & spending mostly positive –
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in comparison with industrialized countries.
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Correlations between Gov.t Spending & GDP
1960-1999
procyclical
Adapted from Kaminsky, Reinhart & Vegh (2004)
countercyclical
G always used to be pro-cyclical
for most developing countries. 8
The procyclicality of fiscal policy
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A reason for procyclical public spending:
receipts from taxes & royalties rise in booms.
The government cannot resist the temptation
to increase spending proportionately, or more.
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Then it is forced to contract in recessions,
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thereby exacerbating the swings.
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Two budget items account for much
of the spending from oil booms:
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(i) Investment projects.
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Investment in practice may be
“white elephant” projects,
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which are stranded without funds
for completion or maintenance
when the oil price goes back down.
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Gelb (1986).
Rumbi Sithole took this photo
in “Bayelsa State
in the Niger Delta,in Nigeria.
The state government
received a windfall of money
and didn't have the capacity
to have it all absorbed in
social services so they decided
to build a Hilton Hotel.
The construction company
did a shoddy job, so the tower
is leaning to its right and
it’s unsalvageable..”
(ii) The government wage bill.
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Oil windfalls are often spent on public sector wages.
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Medas & Zakharova (2009)
Arezki & Ismail (2010):
government spending rises in booms, but is downward-sticky.
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The procyclicality of fiscal policy, cont.
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An important development -some developing countries, including
commodity producers, were able to break
the historic pattern in the most recent decade:
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taking advantage of the boom of 2002-2008
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to run budget surpluses & build reserves,
thereby earning the ability to expand
fiscally in the 2008-09 crisis.
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Chile, Botswana, Malaysia, Indonesia, Korea…
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How were they able to achieve counter-cyclicality?
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Correlations between Government spending & GDP
2000-2009
procyclical
Frankel, Vegh & Vuletin (2012)
countercyclical
In the last decade,
about 1/3 developing countries
switched to countercyclical fiscal policy:
Negative correlation of G & GDP.
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Four questions for macro management
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1. How can a country avoid excessive credit creation
& inflation in a commodity boom ?
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Eventually allow some currency appreciation.
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But not a free float. Accumulate some fx reserves first.
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Raise banks’ reserve requirements.
2. Nominal anchor for monetary policy:
What is it to be, if not the exchange rate? CPI?
3. Fiscal policy:
How can governments be constrained from
over-spending in boom times? Fiscal rule?
4. How should commodity funds be managed?
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1) The challenge of designing
a monetary regime for countries where
terms of trade shocks dominate the cycle
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Fixing the exchange rate (as noted)
leads to pro-cyclical monetary policy:
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Money flows in during commodity booms.
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Excessive credit creation can lead to inflation.
Example: Saudi Arabia & other Gulf countries
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during the 2003-08 oil boom.
Money flows out during commodity busts.
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Credit squeeze can lead to excess supply,
recession & balance of payments crisis.
Example: Exporters of oil & other commodities
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in 1980s, 1997-98.
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Currency regime,
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Floating accommodates terms of trade shocks:
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If terms of trade improve,
currency automatically appreciates,
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preventing excessive money inflows, overheating & inflation.
If terms of trade worsen,
currency automatically depreciates,
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continued
preventing recession & balance of payments crisis.
Disadvantages of floating:
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Volatility can be excessive;
Dutch Disease can be worse:
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pro-cyclicality of real exchange rate.
One needs a a nominal anchor.
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Pro-cyclical real exchange rate
Countries undergoing a commodity boom experience
real appreciation of their currency
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The resulting shift of land, labor & capital
out of manufacturing, and into the booming
commodity sector might be
appropriate & inevitable,
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to the extent it is expandable,
especially if the commodity price rise
is permanent.
But the shift out of manufacturing into NTGs is
often an undesirable macroeconomic side effect –
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the “disease” part of Dutch Disease.
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Monetary regime
If the exchange rate is not to be
the monetary anchor, what is?
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The popular choice of the last decade:
Inflation Targeting.
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But CPI target can react perversely
to supply shocks
 & terms of trade shocks.
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Needed:
Nominal anchors that accommodate
the shocks that are common
in developing countries
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Supply shocks:
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Nominal GDP targeting
Terms of trade shocks:
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Product Price Targeting
PPT
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Nominal Income target
moderates effects of supply shocks
Adverse
AS shock
P
AS
NI
target
•
IT
•
•
AD
Real
GDP
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Product Price Targeting
PPT
accommodates terms of trade shocks
Target an index of domestic production prices
[1]
such as the GDP deflator.
•
Include export commodities in the index
& exclude import commodities,
• so money tightens & the currency appreciates
when world prices of export commodities rise
• accommodating the terms of trade -• not when prices of import commodities rise.
•
The CPI does it backwards:
• It calls for appreciation when import prices rise,
• not when export prices rise !
[1] Frankel (2011, 2012).
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Why is PPT better than a fixed exchange rate
for countries with volatile export prices?
PPT
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If the $ price of the export commodity goes up,
the currency automatically appreciates,
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moderating the boom.
If the $ price of the export commodity goes down,
the currency automatically depreciates,
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moderating the downturn
& improving the balance of payments.
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Why is PPT better than CPI-targeting
for countries with volatile terms of trade?
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PPT
If the $ price of imported commodity goes up,
CPI target says to tighten monetary policy
enough to appreciate the currency.
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Wrong response.
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PPT does not have this flaw .
(E.g., oil-importers in 2007-08.)
If the $ price of the export commodity goes up,
PPT says to tighten money enough to appreciate.
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Right response.
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CPI targeting does not have this advantage.
(E.g., Gulf currencies in 2007-08.)
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3. How can countries avoid
pro-cyclical fiscal policy?
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“Good institutions.”
What are they, exactly?
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Who achieves counter-cyclical fiscal policy?
Countries with “good institutions”
”On Graduation from Fiscal Procyclicality,”
Frankel, Végh & Vuletin; J.Dev.Economics, 2013.
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The quality of institutions varies,
not just across countries, but also across time.
1984-2009
Frankel, Végh
& Vuletin,2013.
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How can countries avoid fiscal expansion in booms?
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What are “good institutions,” exactly?
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Rules?
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Budget deficits or debt brakes?
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Rules for cyclically adjusted budgets?
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Have been tried many times. Usually fail.
Countries more likely to be able to stick with them.
But…
An under-explored problem:
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Over-optimism in official forecasts
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of growth rates & budgets.
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Over-optimism in official forecasts
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Statistically significant bias among 33 countries
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(2011, 2012).
If the boom is forecast to last indefinitely,
there is no apparent need to retrench.
BD rules don’t help.
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Frankel
Leads to pro-cyclical fiscal policy:
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Worse in booms.
Worse at 3-year horizons than 1-year.
The SGP worsens forecast bias for euro countries.
Cyclically adjusted rules won’t help the bias either.
Frankel & Schreger
(2013).
Solution?
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The example of Chile
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1st rule – Governments
must set a budget target,
2nd rule – The target is structural:
Deficits allowed only to the extent that
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(1) output falls short of trend, in a recession, or
(2) 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,
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where forecasts in booms were biased toward optimism.
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Chilean fiscal
institutions
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In 2000 Chile instituted its structural budget rule.
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The institution was formalized in law in 2006.
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The structural budget surplus must be…
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0 as of 2008 (was higher before, lower after),
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where structural is defined by output & copper price
equal to their long-run trend values.
I.e., in a boom the government can only spend
increased revenues that are deemed permanent;
any temporary copper bonanzas must be saved.
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The Pay-off
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Chile’s fiscal position strengthened immediately:
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Public saving rose from 2.5 % of GDP in 2000 to 7.9 % in 2005
allowing national saving to rise from 21 % to 24 %.
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Government debt fell sharply as a share of GDP
and the sovereign spread gradually declined.
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By 2006, Chile achieved a sovereign debt rating of A,
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several notches ahead of Latin American peers.
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By 2007 it had become a net creditor.
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By 2010, Chile’s sovereign rating had climbed to A+,
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ahead of some advanced countries.
=> It was able to respond to the 2008-09 recession
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via fiscal expansion.
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In 2008, with copper prices spiking up,
the government of President Bachelet had been
under intense pressure to spend the revenue.
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She & Fin.Min.Velasco held to the rule, saving most of it.
Their popularity fell sharply.
When the recession hit and the copper price came
back down, the government increased spending,
mitigating the downturn.
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Bachelet & Velasco’s
popularity reached
historic highs by the time
they left office
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4. Manage commodity funds professionally.
Invest them abroad
 like Norway’s Pension Fund,
 Reasons:
(1) for diversification,
 (2) to avoid cronyism in investments.
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but insulated from politics
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like Botswana’s Pula Fund.
Professionally managed, to optimize financially.
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References by the author
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“The Natural Resource Curse: A Survey of Diagnoses and Some
Prescriptions,” 2012, Commodity Price Volatility and Inclusive Growth in
Low-Income Countries , R.Arezki et al., eds.; HKS RWP12-014.
“How Can Commodity Exporters Make Fiscal and Monetary Policy Less
Procyclical?” Natural Resources, Finance & Development, R.Arezki,
T.Gylfason & A.Sy, eds. (IMF), 2011. HKS RWP 11-015.
“On Graduation from Fiscal Procyclicality,” 2013, with C.Végh & G.Vuletin;
http://www.hks.harvard.edu/fs/jfrankel/
J. Dev. Economics.
“A Solution to Fiscal Procyclicality: The Structural Budget Institutions
Pioneered by Chile,” Central Bank of Chile WP 604, 2011.
"Product Price Targeting -- A New Improved Way of Inflation Targeting,"
in MAS Monetary Review XI, 1, 2012 (Monetary Authority of Singapore).
“A Comparison of Product Price Targeting and Other Monetary Anchor
Options, for Commodity-Exporters in Latin America," Economia, 2011
(Brookings), NBER WP 16362.
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