IDEAS home Printed from https://ideas.repec.org/p/boe/boeewp/308.html
   My bibliography  Save this paper

Optimal emerging market fiscal policy when trend output growth is unobserved

Author

Listed:
  • Gregory Thwaites

Abstract

This paper is concerned with how fiscal policy in emerging markets should respond to economic fluctuations. We model the behaviour of a fiscal authority in an emerging market country who can use external borrowing to smooth the effects of exogenous output shocks on domestic agents’ private consumption. We focus on the policy implications of the facts that (1) the GDP process in emerging markets is characterised by a relatively volatile trend growth rate, and (2) that policymakers cannot directly observe the output gap or the trend GDP growth rate. We have two key findings. First, we find that risk-averse policymakers who face EME-style output processes (ie processes dominated by shocks to the trend growth rate) should run tighter fiscal policies, with lower average debt-GDP ratios, than those in industrialised countries, who face different output processes. Second, our baseline parameterisation suggests that EME policymakers should run countercyclical fiscal policies. This result contrasts with other papers which have used optimising frameworks and the features of EME output processes to rationalise the observed procyclicality of EME fiscal policies or external balances. Simulations suggest that the welfare costs of naively running a fiscal policy that would be appropriate for an industrialised country are around 1% of certainty-equivalent consumption, but this result is sensitive to parameterisation. We find that a simple rule-of-thumb policy that stabilises the debt-GDP ratio in every period entails much smaller welfare losses.

Suggested Citation

  • Gregory Thwaites, 2006. "Optimal emerging market fiscal policy when trend output growth is unobserved," Bank of England working papers 308, Bank of England.
  • Handle: RePEc:boe:boeewp:308
    as

    Download full text from publisher

    File URL: http://www.bankofengland.co.uk/research/Documents/workingpapers/2006/WP308.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Jacques A Miniane, 2004. "Productivity Shocks, Learning, and Open Economy Dynamics," IMF Working Papers 04/88, International Monetary Fund.
    2. Aaron Tornell & Philip Lane, 1994. "Are Windfalls a Curse? A Non-Representative Agent Model of the Current Account and Fiscal Policy," NBER Working Papers 4839, National Bureau of Economic Research, Inc.
    3. Yue, Vivian Z., 2010. "Sovereign default and debt renegotiation," Journal of International Economics, Elsevier, vol. 80(2), pages 176-187, March.
    4. Aguiar, Mark & Gopinath, Gita, 2006. "Defaultable debt, interest rates and the current account," Journal of International Economics, Elsevier, vol. 69(1), pages 64-83, June.
    5. Levin, Andrew T. & Williams, John C., 2003. "Robust monetary policy with competing reference models," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 945-975, July.
    6. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Végh, 2005. "When It Rains, It Pours: Procyclical Capital Flows and Macroeconomic Policies," NBER Chapters,in: NBER Macroeconomics Annual 2004, Volume 19, pages 11-82 National Bureau of Economic Research, Inc.
    7. Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003. "Debt Intolerance," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 1-74.
    8. Mark Aguiar & Gita Gopinath, 2007. "Emerging Market Business Cycles: The Cycle Is the Trend," Journal of Political Economy, University of Chicago Press, vol. 115, pages 69-102.
    9. Mark Aguiar & Manuel Amador & Gita Gopinath, 2005. "Efficient Fiscal Policy and Amplification," NBER Working Papers 11490, National Bureau of Economic Research, Inc.
    10. Giuliano, Paola & Turnovsky, Stephen J., 2003. "Intertemporal substitution, risk aversion, and economic performance in a stochastically growing open economy," Journal of International Money and Finance, Elsevier, vol. 22(4), pages 529-556, August.
    11. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
    12. Edge, Rochelle M. & Laubach, Thomas & Williams, John C., 2007. "Learning and shifts in long-run productivity growth," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2421-2438, November.
    13. repec:rus:hseeco:123922 is not listed on IDEAS
    14. Neumeyer, Pablo A. & Perri, Fabrizio, 2005. "Business cycles in emerging economies: the role of interest rates," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 345-380, March.
    15. Taimur Baig & Abdul d Abiad, 2005. "Underlying Factors Driving Fiscal Effort in Emerging Market Economies," IMF Working Papers 05/106, International Monetary Fund.
    16. Hansen, Lars Peter & Sargent, Thomas J., 2003. "Robust control of forward-looking models," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 581-604, April.
    17. Robert E. Lucas Jr., 2003. "Macroeconomic Priorities," American Economic Review, American Economic Association, vol. 93(1), pages 1-14, March.
    18. Young Lee & Taeyoon Sung, 2007. "Fiscal Policy, Business Cycles and Economic Stabilisation: Evidence from Industrialised and Developing Countries," Fiscal Studies, Institute for Fiscal Studies, vol. 28(4), pages 437-462, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Kuusi, Tero, 2014. "Consolidation under the Europe’s New Fiscal Rules: Analyzing the Implied Minimum Fiscal Effort," ETLA Working Papers 23, The Research Institute of the Finnish Economy.

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:boe:boeewp:308. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Digital Media Team). General contact details of provider: http://edirc.repec.org/data/boegvuk.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.