Policy Area Papers on Fiscal policy
Trumponomics and Taxation
World Economics, March 2018
At the end of 2017 President Trump signed into law the Tax Cuts and Jobs Act which Republican supporters argue would transform the US economy and stimulate an enduring increase in the rate of economic growth. The motivation behind the legislation appears to be the belief that a reduction in corporate taxation will release a flood of entrepreneurial initiative that will increase investment and, as a consequence, lead to higher wages and sustained faster economic growth. The Reagan administration tried tax cuts before to stimulate growth; not in a conventional neo-Keynesian way aimed at raising aggregate demand, but as a means of strengthening the supply side of the economy. As an economic philosophy, Trumponomics is a rather high-risk strategy. Compared to the early 1980s there is a smaller output gap, a much higher level of national debt and less fiscal space.
Sovereign Wealth Fund Investment in Economic Transformation: Toward an Institutional Framework
& Asim Ali
, World Economics, March 2017
The prospect of prolonged lower hydrocarbon and commodity prices has forced many countries to reconsider both fiscal policy and sovereign wealth fund asset allocation to address possible liquidity needs. In order to analyze the diversity and effectiveness of public investment vehicles it is necessary to recognize that a sovereign wealth fund is a genre of state investment. As a type of state investor sovereign wealth funds sit within an institutional continuum that includes many other bodies, such as national development banks. Well-functioning operating and governance models have evolved among large-scale private equity investors and components of these are suited to government application.
Measuring the Performance of Fiscal Reforms: The Case of the GCC
Ahmed Hashim Alyushaa
, World Economics, March 2017
Public spending has raised the welfare of citizens in the Gulf Cooperation Countries (GCC) significantly over the period 1960–2015, particularly as measured in raised average life expectancy and lowered infant mortality rates. Fiscal policy in oil-producing countries is pro-cyclical, producing sharp fluctuations in the business cycle, but reliance on oil revenue provides challenges for future improvements in development. For the first time in decades all the GCC economies are going through major economic reforms aimed at increasing efficiency while enhancing the economic welfare of the residents. GCC countries are reforming subsidies, particularly for energy, diversifying tax revenues by introducing value-added taxes and privatizing state enterprises in the provision of electricity and water.
Fiscal Policy and the Global Crisis
, World Economics, March 2016
Up until the global economic crisis at the end of the 2000s an eclectic approach to fiscal policy seemed to have emerged from the long-standing debates that there had been about it. This largely ruled out using fiscal policy to fine tune the economy. Instead macro policy in advanced economies focused on monetary policy within a framework of inflation targeting. In the depths of the recession, however, and with interest rates approaching a zero lower bound, fiscal policy was dramatically resurrected and a broad global consensus formed around fiscal stimulus. The consensus did not last long and sharp disagreements soon re-emerged, in particular with respect to the speed and nature of fiscal consolidation. Why did these changes in the approach to fiscal policy happen and were they appropriate? Does the available empirical evidence allow us to form conclusions about the impact of fiscal policy or is it still a matter of ‘on the one hand…but on the other’? And how might fiscal policy evolve in the light of recent experience? This article examines these questions.
What is Britain worth to the next generation?
, World Economics, June 2015
Government economic policy implicitly aims to build up useful reserves for future generations, or at least to not burden our children and grandchildren with unsustainable debt. Surprisingly, even though this must be an important policy objective, it is rarely discussed or measured. This paper estimates what Britain is now worth to the next generation and we explain how well recent British governments have done in building up value to hand on. The results are eye-watering for anyone who has assumed that there has been a steady build-up of wealth.
The Greek Economic Crisis - is the Euro to Blame?
, World Economics, September 2014
The euro has been at the centre of reporting and discussion on Greece’s economic crisis. This article analyses the build-up, outbreak and development of the crisis in Greece, with the aim to answer whether the crisis can be traced to the country’s entrance into the Eurozone. By identifying a few of the underlying causes of the crisis, the article concludes that Greece’s crisis cannot be blamed on membership of the EMU. Nor is the financial meltdown and global recession of 2007–2008 to blame. Even without the euro, it is likely that Greece would have found itself in an economic crisis.
Macroeconomic Policy in Open Economies: Why Do Economists Disagree?
& Graham Bird
, World Economics, September 2014
The dilemma facing policymakers is how to combine the instruments they have available in the form of fiscal, monetary and exchange rate policy to achieve the targets of internal and external balance. Shortly before the global economic and financial crisis in 2008 most economies appeared to be close to internal balance, but many of them deviated from external balance either in the form of large current account deficits or surpluses. In the aftermath of the crisis and for most advanced economies there was a sharp departure from internal balance, and policymakers in these countries faced a daunting challenge to restore it. The challenge was much less severe for many emerging economies. This article examines whether the analytical framework devised by Meade, Mundell and Fleming in the 1950s and 1960s provides a suitable basis for describing and evaluating the options open to them. It also uses this framework to examine and briefly assess the strategies pursued by the US, China and Greece, and to explain why economists continue to disagree on what policies are appropriate.
When Money Matters: Some Policy Lessons from the Business Cycle in Spain, 1998–2013
José Luis Cendejas Bueno
, Félix-Fernando Muñoz
& Juan Castañeda
, World Economics, June 2014
The severe financial crisis that grips Spain has multiple causes. One has been the massive and continued expansion of the money supply since Spain’s accession to the Eurozone, and the non-negligible effects of this expansion on asset prices as well as on the structure of the economy. We analyse the main hypotheses underlying the mainstream macroeconomic models used in recent years to explain inflation and its relation to money. We then apply an ‘unobserved component model’ to test for the cyclical relation between money growth, inflation, asset (stock and real estate) prices and real GDP in Spain from 1998 to 2013. Based on the Spanish experience, our main finding is that, even though the money supply has become endogenous within the monetary strategy developed by the US Federal Reserve and the European Central Bank in recent times, the broad money supply and asset prices have shared the same cyclical component in the latest business cycle (1998–2013).
Reserve Creation and Reserve Pooling in the International Monetary System
Dr Richhild Moessner
& William A. Allen
, World Economics, June 2014
The paper reviews the arrangements for meeting additional post-crisis demand for international liquidity. It distinguishes between reserve creation and reserve pooling as a basis for multilateral liquidity facilities; reserve pooling arrangements carry the risk that, in a general crisis, all the members will want to draw at the same time. We analyse the recently agreed enlargement of the International Monetary Fund from this perspective, and conclude that the IMF will carry much more liquidity risk after its enlargement than it has done in the past.
Managing a Changing World Economy: Challenges and scenarios
, World Economics, December 2013
The world economy has been experiencing a period of great and dramatic change. In part this has been associated with the rapid emergence of China, the BRICs and other newly industrialising economies. Evolution in the world economy is quickly changing the structure of global output and trade. It is also having implications for the pattern of international capital flows. Alongside these evolutionary changes, the ‘shock’ of the global economic and financial crisis that erupted in 2008 has brought about further changes. Confidence in the efficiency of financial markets has been adversely affected, if not undermined, and consensus over the design of macroeconomic policy has been replaced by substantial areas of division and confusion. The changes have generated broad areas of uncertainty, which in turn have adverse consequences for global economic performance. This article explores these changes and goes on to analyse the issues they raise in terms of managing the world economy. It assesses approaches based on enhanced global economic governance, coalitions based on economic characteristics or regional proximity and economic nationalism.
Strengthening the Early Warning Exercise: Enhancing IMF and FSB coordination
, Skylar Brooks
, Michael Cockburn
, Warren Clarke
& Dustyn Lanz
, World Economics, September 2013
Following the 2007–2008 global financial crisis, the G20 leaders tasked the International Monetary Fund (IMF) and the newly created Financial Stability Board (FSB) to jointly undertake Early Warning Exercises (EWEs) in order to identify vulnerabilities within the global financial system and encourage appropriate policy responses. This paper argues that a series of challenges have prevented the EWE from realizing its full potential. In particular, the advantages accruing from the joint nature of the exercise have not been fully realized. The paper then puts forward recommendations intended to improve the process and encourage implementation of EWE findings among national policymakers.
The Eurozone: Whatever happened to convergence?
, World Economics, June 2013
This article examines the degree of convergence of the economies of the eurozone since the start of the single currency in 1999. Convergence, both in nominal and real forms, is measured using the coefficient of variation of several economic variables. The results suggest that while there was some convergence on inflation up to 2007, there was no convergence on economic growth, total government debt, budget deficits, unemployment or GDP/head. The financial crisis and global recession of 2007 and 2008 exposed a fault line in so large and diverse a currency union, and this now threatens the long-term future of the euro.
The Collapse of Consensus: The contemporary confusion over macroeconomic policy
, World Economics, March 2013
Consensus in macroeconomics helps policymakers formulate a coherent and logically consistent group of policies. At different times in the post-war era there has been consensus around first Keynesian and then monetarist ideas. Economic crises have frequently brought one type of consensus to an end, allowing another to be formed. For much of the 1990s and 2000s there seemed to be consensus built on compromise about the way in which fiscal and monetary policy should be used. However, this collapsed with the global financial and economic crisis. For a brief interlude, a Keynesian consensus re-emerged, but this did not last. At present, there are sharp divisions among economists concerning the effects of macroeconomic policy, and this means that life has become much more confusing for policymakers. This article explores what has been going on, and considers the implications for the future.
Why Hasn’t the US Economic Stimulus Been More Effective?: The debate on tax and expenditure multipliers
F. Gerard Adams
& Byron Gangnes
, World Economics, December 2010
Recently questions have been raised about the effectiveness of fiscal stimulus policies, and about whether stimulus to a recessionary economy should be in the form of tax cuts or expenditure increases. This paper evaluates alternative empirical approaches to measuring the impact of fiscal policy and presents new results based on simulations of a large econometric model of the US economy.
The US economic stimulus has not been more effective because, large as it is, it has not been sufficient to offset the impact of a serious recession and because it has been phased in slowly. Multiplier simulations and other studies suggest that the recession would have been considerably more serious in the absence of the economic stimulus programme.
Financial Crises and Social Spending: The impact of the 2008–2009 crisis
& Marijn Verhoeven
, World Economics, December 2010
Financial crises in developing and transition countries have often proven disruptive to policies and programmes due to procyclical trends in government spending growth. Given the importance and significant proportion of public budgets devoted to education and health, cuts in government expenditures during recessions potentially place social programmes at risk. This paper analyses the experiences from 1995–2007 for 131 countries, projects fiscal social spending to 2013, and examines specific issues around fiscal social spending in the current crisis, including donor responses and government and household coping mechanisms.
Growth rate trends in education and health spending fluctuate over time, with greater volatility in education. Despite the variation on growth rate trends, absolute levels of fiscal spending rise steadily over time, with brief flat trends over one or two years, reflecting periods of GDP growth decline. Public spending tends to be more counter-cyclical for education compared to health. While sharp declines in growth rates of fiscal social spending are projected, they are balanced by projected increases in absolute spending over the 2008–2013 period.
Keywords: AIDS, Business cycles, Education, Fiscal policy, Government spending, Health, HIV, Latvia, Recession, Romania, Social security
The Euro Crisis: It isn’t just fiscal and it doesn’t just involve Greece
, Thomas D. Willett
& Nan Zhang
, World Economics, December 2010
The crisis in Greece and other mainly southern Eurozone countries has been discussed primarily as a fiscal issue. Current account deficits of the same countries have received less attention in spite of the relatedness of current account and fiscal deficits. We argue that the failure of many countries within the Eurozone to develop adequate internal adjustment mechanisms is also an important factor behind the crisis. After reviewing the major perspectives that have been offered on the crisis, we present data that support our argument by demonstrating the lack of price and cost convergence in the Eurozone since 1999. Ironically, it seems that the surplus countries have carried out more of the adjustment pointed to by the endogenous optimum currency area (OCA) theory than the deficit countries. We recommend that the responsibility of a ‘European Debt Surveillance Authority’ should include surveillance of intra-euro payment flows, imbalances and adjustment in labour and goods markets, and setting benchmarks for the Eurozone guarantees of sovereign debt based on ability to adjust internally. Thereby, a potential moral hazard problem of an implicit Eurozone guarantee of countries’ sovereign debt could be avoided.
Keywords: Competitiveness, Debt, Fiscal policy, Germany, Greece, Imbalances, Ireland, Monetary Union, Portugal, Sovereign debt, Sovereign default, Spain, Speculation, USA
The Unfolding Sovereign Debt Crisis
, World Economics, December 2010
After the excessive expansion of new forms of private sector credit over two decades of disinflation, a huge pyramid of global liquidity was accumulated. That sparked a boom in asset prices (stocks, bonds and real estate) way beyond anything experienced in the growth of production, investment or consumption. Eventually the bubble burst and along came the credit crunch and the ensuing Great Recession. Desperate to avoid a meltdown in global financial institutions and another Great Depression, governments have dramatically increased sovereign debt issuance to fund bank bailouts and provide fiscal stimulus to the real economy. Monetary authorities have generated huge increases in liquidity to finance this debt. So, instead of the private sector deleveraging, there has been a massive increase in public sector leverage heaped on top of existing private sector debt. Soon central banks will have to withdraw this liquidity largesse or face a major acceleration in global inflation and another credit bubble. This poses a new stage in New Monetarism as sovereign debt competes with the private sector for available global savings.
At best, the global cost of capital is going to rise sharply, pushing economic growth of the major countries below trend for a decade ahead. At worst, there is a serious risk of a succession of sovereign debt defaults that could plunge the world back into depression. Sovereign debt is being discredited. There is a way out, but governments need to take painful, but necessary, actions.
Keywords: Debt, Fiscal policy, Global financial crisis, Global imbalances, Greece, Japan, Keynesian, Recession, Recession, Sovereign debt, USA
Faulting Internationally Coordinated Fiscal Stimulus
Anthony J. Makin
, World Economics, September 2010
Fiscal policy has been actively deployed globally by G20 governments to counter the impact of the global financial crisis on the real sectors of their economies. This coordinated fiscal response has involved a mix of new public expenditure, including on infrastructure, tax relief and increased income transfers to favoured groups. In the end, the case for fiscal stimulus rests on the presumption that it works in theory, along lines first proposed by Keynes. Yet, Keynesian fiscal activism founded on this presumption is contestable on numerous theoretical and practical grounds. This paper addresses key concerns about the consequences of using fiscal stimulus. It proposes that discretionary fiscal measures that have increased budget deficits and public indebtedness for economies worldwide entail significant macroeconomic costs and risks, and that, as a corollary, reducing unproductive public spending can be expansionary.
Keynes in the Long Run
, World Economics, December 2007
In the light of recent market volatility, this essay asks: is Keynes dead or alive? The broad conclusion is that while macroeconomic models are still used, very little survives of Keynes’s original theory. 'New Keynesians' have replaced his key concept of radical uncertainty by models of imperfect information and 'sticky prices'. These can be used to justify policy interventions, but they attract only a minority of economists. By contrast, Keynesian policy is much more alive, and most monetary authorities and Treasuries are prepared to counter potential output gaps. This is for political rather than for theoretical reasons. A worrying gap, therefore, exists between economic theory and economic policy. At the same time Keynes remains alive in unexpected places and ways: notably in developing countries (though he never addressed development issues) and through occasional, less theoretical writings like his Economic Possibilities for Our Grandchildren. His reflections on the link between economics and ethics are important for our day, and his actual life remains exemplary.
Are Governments Overextended?: Assessing the spectrum of a government’s debts and its exposure to risk
Peter S. Heller
, World Economics, December 2004
Have government debt levels reached dangerous levels? Certainly, for some
countries, the data would suggest so. However, this paper will argue that for
many governments, the amount of explicit debt on their balance sheets seriously
understates the magnitude of their future fiscal obligations. This clearly emerges
from the assessment of many analysts on the size of the prospective fiscal
obligations associated with aging populations. But this point is further reinforced
if one examines the range of other fiscal risk exposures of governments. Thus, an
examination of a government’s explicit debt should only be the starting point for
assessing the sustainability of a government’s fiscal position.
How to Reform Europe’s Fiscal Policy Framework
& Giancarlo Corsetti
, World Economics, March 2003
The current budgetary problems of some EU member states have intensified the
debate on Europe’s fiscal policy framework. It is not enough to change the
interpretation of the Stability and Growth Pact. More fundamental revisions of
the EU Treaty are needed in order to strike a reasonable balance between longrun
sustainability and short-run flexibility. The ceiling on budget deficits should
be conditioned on the government debt level, such that the scope for stabilisation
policy in downswings is increased in low-debt countries. In addition, the enforcement of the rules should be depoliticised: decisions on sanctions against
states violating the rules should be transferred from the political level of the
Council of Ministers to the judicial level of the European Court of Justice.
Keywords: Austria, Belgium, Budget deficit, Bulgaria, Cyprus, Czech Republic, Debt, Denmark, Estonia, EU, Euro, Finland, Fiscal policy, Flexibility, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Portugal, Romania, Slovakia, Slovenia, Spain, Stability and growth pact, Sweden, UK
The Growing US Fiscal Gap
, World Economics, December 2002
The United States has a huge long-term fiscal gap, perhaps with a present value
as great as $74 trillion. The US may thus be unable to continue meeting its
current spending commitments without eventually enacting huge tax increases.
The tax cut enacted in 2001 may have increased the fiscal gap by about $13 trillion,
but the main cause of the gap is increasing life expectancy, which raises the cost
of Social Security and Medicare. While the fiscal gap can in theory be eliminated
at the stroke of a pen by simply changing stated policy, in practice this could lead
to serious disruption of people’s expectations. In addition, the fiscal gap may
impair future generations’ opportunity to take full advantage of technological
advances (such as in treating cancer) that have the potential to make their lives
significantly better than ours.
James Tobin, 1918–2002
An interview with introduction by Brian Snowdon & Howard Vane
World Economics, September 2002
Professor James Tobin, who died on 11 March 2002, was possibly the most eminent
of the world’s ‘Keynesian’ economists. Described by Nobel Laureate Paul Samuelson
as “the archetype of a late-twentieth century American scholar”, Tobin was
without doubt one of the most influential economists of his time who inspired a
whole generation of students. In this interview, Professor Tobin discusses the
progress and development of economics in the second half of the twentieth century.
Is Public Spending Good for You?
, World Economics, June 2001
Studies by psychologists, sociologists and economists indicate that increases in incomes beyond about US$4,000 are not related to happiness nor significantly with the objective quality-of-life indicators (which increase with scientific and technological breakthroughs at the global level). Yet everyone wants more money.
This may be explained by environmental disruption, relative-income effects, inadequate recognition of adaptation effects, and the materialistic bias due to our accumulation instinct and advertising. These factors cause a bias towards private consumption, making public spending, especially on research and environmental protection (with their long-term and global public-good nature) well below optimal. This is made worse by economists’ emphasis on the excess burden of taxation, ignoring the negative excess burden on the spending side.