Discussion of “The Austerity Myth”-
Gain without Painby Roberto Perotti*
Roland Straub European Central Bank
Budapest, 16 September 2011
*The views expressed in this presentation are mine and do notnecessarily reflect those of the ECB or the Eurosystem
What is the paper about? Expansionary fiscal consolidation (EFC) hypothesis
Controversy between AAP and IMF studies AAP: fiscal consolidation (CAPB measure) may be expansionary if
implemented by cutting government spending IMF study: effects are biased; new estimates (action based using
historical records as in Romer and Romer, 2010) suggest that fiscal consolidation has contractionary effects
Perotti (2011): IMF criticism is correct in principle, but has its own limitations
Case studies of fiscal consolidation episodes Denmark, Ireland, Finland and Sweden provides some evidence on
the existence of EFC Though unlikely in the current environment
What is the paper about? General problems in identifying the impact of fiscal
shocks on output Countercyclical response problem: policy maker
might implement systematic, countercyclical changes to policy parameters (e.g. tax rates) to react to the current states of the economy
Imperfect cyclical adjustment: surplus reacts automatically to asset prices, because their effects on tax revenues (standard CAPB do not correct for that)
IMF: AAP study using CAPB is subject to both, which can explain the differences between the two studies
Perotti (2011): IMF study might also be subject to the countercyclical response problem, so coefficients might be biased towards zero.
IMF vs. AAP vs. Perotti (2011) Perotti (2011) : IMF and AAP agree that on average
fiscal consolidations are associated with a recession in the short-run. Main issue of contention: spending based consolidation
IMF (contractionary) vs. AAP (expansionary) Arguments used by the IMF study to explain
differences are incorrect Both effects create a positive bias between revenue
based increases in surplus and GDP growth. But the AAP estimates are actually negative, so removing
this effect would reinforce the main finding of AAP. Censoring bias of the IMF approach, as only positive
values of fiscal shocks are recorded Omitting the countercyclical response
Comments: CAPB vs. Action Based approach Do IMF and AAP agree that, on average, fiscal consolidations are associated with the recessions in the short-run?
Comments: censoring bias To test whether these effects matter, set all
negative changes also in the CAPB-to-GDP ratio to zero
Comments: omitting the countercyclical response
Quote: “While omitting the countercyclical response of fiscal policy has an obvious motivation for the purpose of estimating the multiplier of fiscal policy actions, it can provide the wrong picture of the actual fiscal policy stance when trying to gather the size of fiscal consolidations”
True motivation is indeed difficult to identify, even in an action based approach.
Tough call…
Case studies: main findings Discretionary fiscal consolidations are often
smaller than estimated in the past All stabilization were associated with
expansions in GDP. Except in Denmark, all stabilization were driven by
exports Denmark: internal devaluation using
nominal exchange rate as a nominal anchor. Wage restraints and income policies as a
substitute of a devaluation The expansion was followed by a slump that
lasted for several years
Case studies: main findings
Quote from Perotti ( 2011), page 5:“Some of the conditions made these
consolidationsexpansionary - (i) a decline in interest rates
from very high levels, (ii) wage moderation relative to
other countries, perhaps supported by income
policies- seem not to be applicable in the present
circumstances. “
The Question of the Day
Quote: “To be sure fiscal multipliers depend on the state of the economy and can change overtime. But can they change sign in a little over a year? Does any model exist to show that 18 months ago it made sense for the United Kingdom to expand fiscal policy, while now it makes sense to implement the recently announced 25 percent nearly across-the-board budget cuts.”
The Question of the Day
Quote: “To be sure fiscal multipliers depend on the state of the economy and can change overtime. But can they change sign in a little over a year? Does any model exist to show that 18 months ago it made sense for the United Kingdom to expand fiscal policy, while now it makes sense to implement the recently announced 25 percent nearly across-the-board budget cuts.”
Leeper (2010), Jackson Hole Symposium
Decomposing Euro Area GDP
2007Q3 2008Q1 2008Q3 2009Q1 2009Q3-3.5
-3
-2.5
-2
-1.5
-1
-0.5
0
0.5
Real GDP Growth Euro Area - Historical Decomposition
Per
cent
(Ann
ualiz
ed q
-o-q
)
Fiscal Shocks Non-Fiscal ShocksReal GDP Growth
Coenen , Straub and Trabandt (2010):
Expansionary Fiscal Contraction Theoretical Studies Under some conditions can be successful
Bertola/Drazen, 1993; Perotti, 1999; Sutherland, 1997;
Fiscal consolidation generate economic contraction Erceg and Linde, 2010 Angeloni, Faia, Winkler, 2010
Expansionary Fiscal Contraction
(i) Are we in a low interest rate environment?
(ii) Is wage moderation relative to other countries, perhaps supported by income
policies, applicable in the present circumstances?
Comments: Are we in a low interest rate environment?
Monetary Policy Rates
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
01/01/08 01/12/08 01/11/09 01/10/10 01/09/11
Euro Area United States
Comments: Are we in a low interest rate environment?
5 years government bond yields
0.0
5.0
10.0
15.0
20.0
25.0
30.0
01/01/08 01/10/08 01/07/09 01/04/10 01/01/11 01/10/11
Germany Spain Finland France Greece Ireland Italy
Comments: CDS spreads
Risk premia and fiscal consolidation Coenen-Mohr-Straub: “Fiscal Consolidation
in the Euro Area: Long-Run Benefits and Short-Run Costs”
New Keynesian DSGE Model A wealth of nominal and real rigidities Detailed modelling of the fiscal sector Standard Taylor Rule –zero lower bound is not
binding Link between real interest rates and government
debt
Risk premia and fiscal consolidation: Long-run effects
Expenditure Based Consolidation
Revenue Based Consolidation
Risk premia and fiscal consolidation at a zero lower bound
Corsetti, Kuester, Meier, Mueller (2011): Identifying conditions under which fiscal retrenchment may actually stimulate economic activity.
Key features Sovereign risk channel ( responsiveness of
interest rate spread to expected deficit) Expected duration of ZLB IS curve (see also Cúrdia and Woodford, 2009)
Impact of fiscal consolidation is state dependent
Expansionary fiscal contraction if Fiscal strain is
pervasive and And monetary
policy is constrained at the ZLB
Risk Premium in an Open Economy
Similar results hold in an open-economy version of the model with monetary union
Wage Moderation: Is it unlikely?
Wage Moderation: Is it unlikely?
Conclusion
Very interesting paper. I agree with most of the conclusions. But, I would argue that there is potentially
a case for having expansionary effects of fiscal contractions even (or especially) in the current environment.
Fiscal Limits and Monetary Policy
Leeper and Walker (2011) Unresolved fiscal stress raises the possibility
that the economies hit fiscal limits Monetary Policy might loose its ability to control
inflation and influence the economy in a usual ways.
Comments: CDS spreads
Credit default Swap spreads, 5 yrs to maturity
0
100
200
300
400
500
600
700
Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11
basi
s po
ints
Corporate
Sovereign
