Transcript Keynote address to African Finance Ministers

Centre for Development Policy and Research
2009 African Caucus
Global Crisis and Africa - Responses, Lessons
Learnt and the Way Forward
Freetown, Sierra Leone
12-13 August 2009
The Global Financial Crisis and
Countercyclical Fiscal Policy
John Weeks
Professor Emeritus
University of London
Global context
Growth of OECD countries has declined dramatically,
bringing down the sub-Saharan countries:
OECD
sub-Sahara
2007 2.9% (actual)
6.0% (actual)
2008: 2.4 (actual)
3.7
(actual)
2009: 0.8 (estimate) 3.0
(calculated)
2010: -4.1 (projection) 0.9
(calculated)
Note: OECD growth from www.oecd.org
Growth of OECD countries and the sub-Saharan region,
1961-2009 (OECD Actual, SSA forecast 2007-2009)
SSA(t)
7.0
2007
OECD (t-1)
5.0
3.0
1.0
2009
2005
2001
1997
1993
-5.0
[Adjusted R2 = .39, coefficient = .44]
1989
-3.0
1985
1981
1977
1973
1969
1965
1961
-1.0
Preventing decline
African governments have two general policy
options. They can ‘hope-for-the-best’, continue
with policies designed for a robust world
economy, and await international recovery.
This would place primary emphasis in macro policy
on preventing inflation, setting a target for the
fiscal deficit, and a free-floating exchange rate.
This option would represent a triumph of hope
over experience.
When the world economy is contracting a fiscal
policy guided by fears of inflation results in a
contraction of domestic demand to aggravate
the contraction in exports.
The other option
Countercyclical fiscal policy:
An active fiscal policy to counter
the international downturn through
management of the public budget to
compensate for fluctuations in
export demand.
A new policy consensus is emerging in favour
of countercyclical responses to the world
downturn.
Policy makers in Africa can take advantage of
and follow this emerging view.
This presentation considers how the
governments of Africa might design and
implement such a policy.
How a fiscal stimulus package works:
Arguments against an
active fiscal policy
An active fiscal policy implies deficits and:
1. Deficits are inflationary
2. Deficits reduce (‘crowd out’) private spending
3. Deficits squeeze other expenditures through
the servicing of the public debt
These are not automatic outcomes, but
‘contingent outcomes’ that depend on the state
of the economy, the size of the deficit and how
it is financed.
Arguments against an
active fiscal policy for African countries:
1. Balance of payments constraint
Overcome with devaluation
2a. Deficit: Inflation threat
The inflationary threat is minor in a depressed
economy because of excess capacity and imports
‘absorption’.
2b. Deficit: ‘Crowding out’ private investment
Mechanism: Public borrowing competes with
private sector for credit
i) will not occur when expenditure is funded
by borrowing directly from central bank
(monetising the deficit)
ii) design new public expenditures to
complement private expenditures.
Argument for an active fiscal policy
An economy with idle resources is inefficient.
The necessary condition for allocative
efficiency is that an economy operate near its
productive potential.
The most important function of macro policy
is to guide the economy to its productive
potential.
An active fiscal policy can be prudent
and responsible,
without need for deficit targets or limits.
The four elements
of an active fiscal policy:
1. Goal
2. Design
3. Implementation
4. Monitoring
A stimulus policy for African countries
1. Goals
Short term:
Prevent decline of the economy and the
poverty that causes
Medium term:
Maintain economic efficiency by keeping the
economy close to potential output
The constraints/risks:
1. Unsustainable fiscal deficit
2. Unmanagable trade deficit
3. Excessive inflation
Preventing decline in GDP would be
achieved by the combination of:
Public expenditure
and
Devaluation
Consistent with
1. small increase in [fiscal deficit/GDP]
2. no increase in [trade deficit/GDP]
3. moderate inflation
2. Design
The stimulus package would be a temporary
measure undertaken in the downturn of the global
cycle.
Taxes are a clumsy instrument for demand
management.
Public expenditure offers the more effective
mechanism to compensate for export demand
fluctuations.
A country’s medium and long term growth rates are
determined by the development of capacity, skills and
technical change.
Public investment contributes to increasing capacity, it
is unwise to use it as a countercyclical instrument.
Using them as a countercyclical instrument would
waste of resources.
Current expenditure has the flexibility for an effective
countercyclical policy.
Design: summary
1. If a country’s potential growth rate is low, increase private
& public investment.
2. Simultaneously use current expenditure for the short term
demand to reach the potential created by past investment.
3. Much of current expenditure is inappropriate for
countercyclical policy because it is long term.
4. Effective countercyclical expenditures use employment
intensive techniques that create projects with low capital
cost that can be initiated and terminated quickly.
3. Implementation
A ‘countercyclical’ expenditure that becomes
permanent negates its purpose.
Initiation and termination could be triggered
by a policy rule based on macroeconomic
indicators.
The specific indicator will vary by country,
determined by the development and structure
of the economy.
4. Monitoring
A countercyclical policy requires monitoring
rules to ensure that a stimulus is sufficient
AND
Stops when it is no longer needed.
Funding of countercyclical programmes
The countercyclical fiscal stimulus in most African
countries must be funded by public sector borrowing.
If the increase in the deficit is not consistent with
other policy goals, such an inflation guideline or size
of the domestic public debt, increased grants could be
sought to fill the funding shortfall.
Exchange rate management
The exchange rate adjustment should be
consciously managed:
1) to prevent a widening trade gap, by
increasing the relative price of tradables;
Countercyclical policy in Latin America in
the 1960s and 1970s failed by generating
unsustainable trade deficits.
2) to prevent excessive exchange rate induced
inflation.
The purpose of the weakening currency is to
increase exports and decrease imports.
This will provoke inflation by the amount of
the devaluation times the propensity to
consume.
While necessary, the exchange rate induced
inflation can destabilise the economy.
Exchange rate policy: summary
Exchange rate management is necessary to
ensure that the desired increase in the price of
traded commodities does not destabilise the
economy.
If the increase in expenditure is ‘too large’
and the currency adjustment ‘too small’,
the stimulus generates a excessive fiscal and
trade deficits.
If the increase in expenditure is ‘too small’
and the currency adjustment ‘too large’,
The stimulus improves the fiscal and trade
deficits, but exceeds the inflation target.
Adjustment dynamics:
To be feasible the fiscal stimulus must have
‘Goldilocks zone’
in which
The fiscal deficit and trade deficit are within
their policy guidelines
and
Inflation is below its guideline maximum.
Implications for donors policy
Success in countering the global recession
requires that donors grant recipient
governments the policy space to use fiscal
policy effectively.
1) reform conditionalities and ‘benchmarks’ by
ending ‘stand-alone’ targets and ceiling set for:
- Fiscal deficits
- Foreign reserve holdings;
- Inflation rates; and
- Monetary supply
Replace with flexible growth-related policy
guidelines. For example, set an inflation
guideline for the medium not short term.
2) increase donor predictability on delivery of
assistance because a fiscal stimulus is
frequently ‘finely tuned’ and late delivery of
assistance could provoke macroeconomic
instability.
3) Shift the focus of ODA negotiations from
reform to recovery.
Preventing poverty:
Fiscal policy for recovery & growth
A carefully calibrated stimulus package plus
donor flexibility can combine to overcome the
effects of the global crisis.
A stimulus package involves risks. These are
minor compared to the effect of the global
depression on poverty and public welfare.