Transcript Should Micro Economies Follow Fiscal Rules?

Should Micro Economies Follow
Fiscal Rules?
Anthony Birchwood 2015.
The University of the West Indies
And Global Development Network
Commonwealth Secretariat.
Structural Predicament of Micro
Economies
• We define micro-economies as countries with
population of under 2 million.
• Many of these states are in the
Commonwealth.
• Many Commonwealth states are plagued with
– large fiscal deficits and
– external current account deficits accompanies by
– high debt overhang.
Why Fiscal rules?
• Would fiscal rules lead to fiscal discipline and
lead to internal balance?
Fiscal rules can curb the tendencies by government
to engage in opportunistic spending.
• Fiscal rules necessary to lead to external
balance.
• Modern economic literature advocates the
practice of fiscal rules to achieve stabilisation.
Can micro-economies follow fiscal
rules?
• Micro-economies are capable of following
fiscal rules but the likelihood of them doing so
– hinges on their relationship with the IFIs, and
– favourable external and internal balances.
– High debt leaves the economy with tight fiscal
space
– Fiscal rules are more likely to be implemented
under conditionality programs with IFIs.
Technique
• This study explores the ability of micro
economies to sustain fiscal rules given
– high debt and
– wide fiscal deficits?
• Study uses panel GMM for the period 2007-11
for 25 micro economies.
What are the most popular rules
• Most popular rules practiced by microeconomies are
– balanced budget rules,
– debt rules and
– expenditure rules. (Okwuokei 2014).
• Mainly with the assistance of IFIs many of
these economies begun adopting these rules
since 1998.
Can micro-economies meet the EU
standards?
• We test to see whether the first best practice
advocated by the EU can be met by microeconomies.
• We control for
– debt overhang of no more than 60% of GDP,
– fiscal deficits of not wider than 3% of GDP.
Formulation of the regression
• We formulate the regression:
– 𝐹𝐵 = 𝑓 𝐶, 𝐶𝐴, 𝐹𝐷𝐼, 𝑌𝑔
• 𝐹𝐵 is overall fiscal balance,
– 𝐶 is a constant,
– 𝐶𝐴 is external current account balance,
– 𝐹𝐷𝐼 is Foreign Direct Exchange and
– 𝑌𝑔 is GDP growth.
Controlling Debt and Fiscal Spreads
• We allow the regression to take place where
the debt is below and then over 60% of GDP.
• We then allow the fiscal spread to be lower
than 3% of GDP and at a balanced budget
level at above -3%
of GDP.
Estimation Results
• External current account and foreign direct
investments are significant to the devising of
fiscal rules for micro-economies.
• Growth turn out to be significant only when debt
level is under 60%.
• Relationship between growth and fiscal balance is
not linear as it depends on debt the severity of
debt.
– So spending more may not lead to growth if it incurs
higher debt overhang.
Conclusion
• When debt is above the ceiling prescribed by
the EU, rules tend to be distorted in effects.
• Designing fiscal rules is only credible if the
country is within debt limits.
Conclusion Cont’d
• Designing fiscal rules for micro economies is
only credible when the country functions
within fiscal and debt limits.