Public Sector Deficits and Macroeconomic Performance in Lebanon: A Simulation Analysis

The main aims of this paper are as follows. First, to macro model prospective development in the Lebanese economy for policy analysis and evaluation. This study develops s a dynamic macroeconomic model for Lebanon including the budget deficit and the funding of it (e.g. by monetary accommodation or bond financing), as well as the composition of government expenditures (capital or current). Hence this paper develops behavioural equations not used before for Lebanon. This macroeconomic model is utilised as well to analyse the effects of exogenous shocks arising from increased government expenditures (capital expenditure or consumption expenditure) upon key macroeconomic variables. The second aim of this study is the application of a simulation analysis to the Lebanese economy, which suffers from fiscal deficits and public debt during last few decades. This study conducts a numerical simulation analysis of the macroeconomic model developed, in order to analyse a number of economic policies in the context of the Lebanese fiscal crisis with the aim of improving the country’s macroeconomic performance. The major findings from the simulation results presented in this study are that, implementing the policy of expansion in government capital expenditure, for two presumed cases (unanticipated/gradual), produces larger favourable impacts (in comparison with the policy of expansion in government consumption expenditure) upon Lebanese economic development in terms of private sector investment, and in terms of the supply side of the economy (crowding in effects) during the whole adjustment process towards long run steady state. Implementing the policy of an expansion in government consumption expenditure produces unfavourable effects in terms of external developments during the adjustment process. This policy produces, as well, unfavourable effect in terms of private investment and aggregate supply (crowding out effect). However, the simulation results for the two policies show that money deficit financing is inflationary and shows large sensitivity in terms of the interest rate. Bond financing is non inflationary and shows little sensitivity in terms of interest rates. The main finding is that if the government considers a fiscal expansion policy in order to improve macroeconomic performance, the simulation results suggest that the government should adopt the policy of an expansion in capital expenditure because it produces the most desirable outcomes. In addition, it should adopt a gradual approach because this produces considerably less volatility in terms of major macro variables. The main findings from our simulation results dealing with the government approach to the fiscal crisis, does not support the government policy in dealing with the crisis. The results presented here suggest that it produces the most undesirable economic outcomes, and hence will only exacerbate Lebanon’s economic difficulties.