Transcript Comments on - Center for Financial Studies

Comments on
“Fiscal Consolidations in Currency Unions:
Spending Cuts Vs. Tax Hikes”
by Christopher J. Erceg and Jesper Lindé
(Federal Reserve Board)
Christiane Nickel (ECB)
Monfispol, Frankfurt, 20 September 2011
These comments should not be reported as representing the views of the European Central
Bank (ECB). The views expressed are those of the author and do not necessarily reflect those
of the ECB.
Summary of the paper
This paper covers an extremely topical issue, which will
remain in the center of attention for many years.
• Literature on fiscal consolidations largely in agreement: Use spending cuts!
• But disregards current circumstances: e.g. currency union member countries, zero bound
constraint.
• This paper is rich and can be applied to many (current) circumstances, esp. in Europe
Main policy lessons from the paper:
To minimize adverse impact on output:
• If monetary policy can respond, use spending cuts because the effects of a labour tax hike
on output would be more severe for a consolidating member of a currency union.
• If monetary policy cannot respond (small member country of a currency union, liquidity
trap) use labour tax hikes because the effects on output are less severe in a member of a
currency union.
• Spending cuts always negative on output irrespective of the way they are implemented
(no expansionary fiscal consolidations as the literature on non-Keynesian effects would
suggest.)
Results derived from a two-country-block DSGE model calibrated to the euro
area.
2
Issues for discussion
1. Temporary vs. permanent consolidation
2. Non-linearities
– Private sector behaviour
– Confidence effects
3. Policy implications for the current situation
– Problematic steady state assumption
– Crude definition of fiscal consolidation
3
1. Temporary vs. permanent consolidation
• In the paper, the tax hike and the spending cut are not
permanent (they follow an AR(1) process, i.e. go back to
“normal” after a while).
• Thus, results could be interpreted as the “flip-side” of
stimulus programmes.
• In this sense, the ECB’s New Area Wide Model yields similar
results for stimulus programmes, i.e.
– Labour tax cuts have a significantly lower multiplier than
government consumption increases.
4
Euro area GDP multipliers: Results from the
NAWM (for fiscal stimulus)
Benchmark
Variable
1 Year Delayed Gradual More Non- Gov. Bond More
More
Nominal Stimulus Stimulus Stimulus Ricardian Yield Risk Flexible Open
Interest Rate
Removal Households Premia
Prices Economy
I
II
III
IV
V
VI
VII
VIII
IX
Increases in expenditure
Government consumption
Government investment
Transfers to all households
Private investment subsidy (tax credit)
1.2
1.1
0.3
2.0
0.8
0.9
0.1
1.0
0.6
0.6
0.1
0.6
0.8
0.8
0.1
1.6
0.6
0.5
0.3
1.4
1.2
1.2
0.4
2.1
1.1
1.0
0.2
2.1
1.3
1.2
0.4
2.4
1.1
1.0
0.2
0.9
Reductions in revenue
Labour income taxes
Consumption taxes
Firms payroll taxes (social sec. contrib.)
Capital income taxes
0.0
0.4
0.1
0.1
0.1
0.3
0.3
0.1
0.1
0.2
0.1
0.0
0.1
0.2
0.2
0.2
0.0
0.2
-0.1
0.5
0.2
0.5
0.1
0.2
-0.1
0.3
-0.1
0.0
0.0
0.5
-0.4
0.2
0.1
0.3
0.3
0.1
Source: ECB Monthly Bulletin, July 2010, p. 77
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1. Temporary vs. permanent consolidation
(continued)
• When considering permanent hikes in labour taxes or
permanent cuts in government consumption, these results
may change.
• Simulations with the ECB’s NAWM show that for a
permanent 30 pp reduction in the debt-to-GDP ratio from
90% to 60% short-run costs of fiscal consolidation are
typically small relative to the permanent gains.
6
Costs and benefits of fiscal consolidations:
NAWM results
No-confidence effects
Including confidence effects
Short-run
Long-run
Short-run
Long-run
(percent/percentage points)
GDP
GDP
GDP
GDP
Permanent reductions in expenditure
Government consumption
Government investment
Transfers to all households
Transfers to non-Ricardian households
-0.6
-0.7
0.3
0.6
0.4
-1.7
1.6
2.2
-0.4
-0.5
0.5
0.8
1.8
-0.3
3.0
3.6
Permanent increases in revenue
Labour income taxes of all households
Consumption taxes
Firms payroll taxes (social sec. contrib.)
Capital income taxes
-0.3
-0.1
-0.6
-0.4
0.5
0.9
0.5
-1.1
-0.1
0.1
-0.4
-0.2
1.9
2.3
1.9
0.4
Source: ECB Monthly Bulletin, July 2010, p. 80
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2. Non-linearities: Private sector behaviour
• In the paper, agents are believed to respond in an unchanged manner in
‘good times’ as in ‘bad times’ but:
• Behavior might change depending on e.g. the level of outstanding
government debt (expectations  private net wealth effects)
• Importance of high or growing government debt noted by among others
Reinhart and Rogoff (2010), Checherita and Rother (2010), Cecchetti et al
(2011), Nickel and Vansteenkiste (2009)
• This might be relevant in a liquidity trap scenario as it often coincides with
already high debt-to-GDP ratios
• Solution: Play with the share of non-Ricardian household. (Empirical
evidence suggests that the crisis has increased the share of liquidity or
credit constrained (non-Ricardian) households.)
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2. Non-linearities (continued): Confidence effects
• Literature on “non-Keynesian fiscal effects” postulates that favourable
expectation effects could more than offset the contractionary impact of
fiscal consolidation on growth.
• The credible announcement and implementation of a fiscal consolidation
strategy may diminish the risk premium associated with government debt
issuance.
• In the paper: risk premium is reduced (very) gradually, i.e. according to the
actual reduction in the debt-to-GDP ration (see chapter 6.4).
• BUT: Already the announcement of a fiscal consolidation package may
reduce the risk premium, i.e. the reduction in the risk premium could be
much quicker -> already on the announcement of the fiscal package.
• See results for NAWM, final two columns of the table on slide 7 for an
“ad hoc” permanent 30 basis point reduction in the financing costs (on the
basis of a permanent fiscal consolidation).
• Suggestion: Expand chapter 6.4.: The reduction in the risk premium could
be much less gradual in case of a credible announcement of a fiscal
consolidation programme.
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3. Policy implications
Steady state assumption is in the current situation problematic.
•
•
•
•
•
As said, paper can be applied to current situation.
However, currently countries consolidate to restore market confidence.
This implies: these countries are not in a steady state.
No consolidation would have meant a situation spiralling out of control.
Given that the model assumes a steady state as a starting point, the policy
implication for the current situation is not clear.
• In addition:
– At times when fiscal consolidation is needed most, raising taxes might
be least implementable for political economy considerations
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3. Policy implications (continued)
Crude definition of consolidation:
• In practice: consolidation is a mix of revenue and expenditure
measures.
• Labour taxes and government consumption are only a part of
total government revenues and expenditure.
• Suggestion: Use a policy mix!
• This suggestion holds even more if one considers the position
of countries on their respective Laffer curves: Trabandt and
Uhlig (2010) show that for the EU-14 the revenues from labour
and capital taxes are hardly increasable. For selected EU
countries they show that it seems impossible to increase
revenues by increasing those type of taxes.
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General government revenue: Euro area (2010)
50
45
Other, 4.6
40
% of GDP
35
Social
contributions,
15.6
30
25
20
Indirect taxes,
13.0
15
10
5
Direct taxes,
11.3
0
Source: AMECO.
12
General government expenditure: Euro area (2010)
60
50
% of GDP
40
Capital
expenditure,
4.1
Consumption,
22.2
30
Interest, 2.8
20
Transfers ,
21.4
10
0
Source: AMECO.
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References
Cecchetti, S. G., M. S. Mohanty and F. Zampolli (2011). The real effects of
debt. BIS Working Paper No. 352.
Checherita, C. and P. Rother (2010). The impact of high and growing
government debt on economic growth - an empirical investigation for the
euro area. ECB Working Paper No. 1237.
ECB (2010). July Monthly Bulletin.
Nickel, C., P. Rother and L. Zimmermann (2010). Major public debt
reductions – lessons from the past, lessons for the future. ECB Working
Paper No. 1241.
Nickel, C. and I. Vansteenkiste (2008). Fiscal policies, the current account
and Ricardian equivalence. ECB Working Paper No. 935.
Reinhart, C. M. and K. S. Rogoff (2010). The Aftermath of Financial Crisis,
American Economic Review, Vol. 99(2), pp. 466-472.
Trabandt, M. and H. Uhlig (2010). The Laffer curve revisited, Journal of
Monetary Economics, doi:10.1016/j.jomeco.2011.07.003.
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