Fiscal Sustainability and Institutional

Change in Nicaragua

Mario Alberto Aráuz TorresBanco Central de Nicaragua

06.08.2019

Outline of presentation

1. Introduction

2. Literature review

3. Methodological issues

4. Analysis and discussion

5. Preliminary conclusions

2

Recent economic performance

3Introduction Theory Method Results Conclusion

Economic growth Inflation

Inflation (%) GDP growth (%)

6.3 6.5

4.9 4.8 4.8 4.6 4.7

-3.8

Average4.1

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

2011 2012 2013 2014 2015 2016 2017 2018

8.0

6.6

5.7

6.5

3.1 3.1

5.7

3.9

Average5.3

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

2011 2012 2013 2014 2015 2016 2017 2018

Source: BCN (2018).

Recent economic performance

4Introduction Theory Method Results Conclusion

NFPS Deficit Public debt

Source: BCN (2018).

PS deficit (% of GDP)

0.2

-0.3

-1.1

-1.5-1.6

-2.0 -2.0

-4.1

Average-1.6

-4.5

-4.0

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

2011 2012 2013 2014 2015 2016 2017 2018

Public debt (% of GDP)

55.653.2 52.7

48.845.1 44.6

46.9

52.5

0.0

10.0

20.0

30.0

40.0

50.0

60.0

2011 2012 2013 2014 2015 2016 2017 2018

Problem statement

Introduction Theory Method Results Conclusion 5

• As of 2013 the Nicaraguan Institute for Social Security went into deficit,

jeopardizing the viability of the social security system.

– To counteract this situation, the government of Nicaragua implemented major

social reforms passed in April 2018.

– This triggered widespread social protests, affecting the economy and stability of

the country, with implications that still stands to this day.

Problem statement

Introduction Theory Method Results Conclusion 6

• As a result, GDP fell to minus 3.8 percent, consumption fell by 4.5

percent, and investment fell by 23.6 percent (BCN 2018a, p. 7).

– This caused a shortfall in tax revenues, affecting the General Budget of the

Republic (GBR) in about USD367.7 Million (cf. BCN 2018b, p. 157).

– Consequently, the government has taken major Fiscal Policy actions, reviewing

and adjusting GBR 2018 and 2019, passing a tax reform, and new measures of

social security.

Research question

To what extend are the new institutions able to revert the current trends of

economic downturn and improve the fiscal position of the government of

Nicaragua?

Introduction Theory Method Results Conclusion 7

Theoretical Foundations

Introduction Theory Method Results Conclusion 8

Source: Based on Blanchard & Perotti (2002), Lavigne (2006).

Effects Fiscal

Policy Shock on

Outcome

Keynesian Approach

Neoclassical Approach

Government

Expenditure Shock

Tax Revenue

Shock

Effect on Consumption

Effect on Investment

Effect on Consumption

Effect on Investment

Robust institutions and governance structures are key to long term and sustained fiscal policy measures

(Lavigne 2006, Persson 2002, Poterba 1994).

Theoretical proposition

In contexts where social conflicts and political instability persist, it will be

wise to adopt austerity measures while working on the reconstruction of the

institutional environment as a pre-condition to undertake successful Fiscal

Policy measures.

Introduction Theory Method Results Conclusion 9

Methodological issues

Introduction Theory Method Results Conclusion 10

General model

𝑌𝑡 = 𝜙 𝐿, 𝑞 𝑌𝑡−1 + 𝑈𝑡𝑡𝑡 = 𝑎1𝑥𝑡 + 𝑎2𝑒𝑡

𝑔+ 𝑒𝑡

𝑡

Where:

𝑌𝑡 = 𝑇𝑡, 𝐺𝑡, 𝑋𝑡

𝑈𝑡 = 𝑡𝑡, 𝑔𝑡 , 𝑥𝑡

Model identification

𝑔𝑡 = 𝑏1𝑥𝑡 + 𝑏2𝑒𝑡𝑡+ 𝑒𝑡

𝑔

𝑥𝑡 = 𝑐1𝑡𝑡 + 𝑐2𝑔𝑡 + 𝑒𝑡𝑥

Variables:⎯ Public spending.

⎯ Tax revenues.

⎯ Real GDP.

Time period: 2006:01 - 2018:04.

Approach: Blanchard & Perotti

(2002)

Methodological issues

Introduction Theory Method Results Conclusion 11

Tax shock

identification

Spending shock

identification

𝐴 =1 0 −𝑎10 1 0−𝑐1 −𝑐2 1

, 𝐵 =∗ 0 0𝑏2 ∗ 00 0 ∗

𝐶 =1 0 00 1 −𝑎1−𝑐2 −𝑐1 1

, 𝐷 =∗ 0 0𝑎2 ∗ 00 0 ∗

Preliminary results

Introduction Theory Method Results Conclusion 12

Figure 1. Structural Spending Shock

Quarter

Source: this study

-.04

-.02

.00

.02

.04

.06

.08

1 2 3 4 5 6 7 8

Response of LEXP to Shock in LEXP

-.01

.00

.01

.02

.03

1 2 3 4 5 6 7 8

Response of LREV to Shock LEXP

-.005

.000

.005

.010

.015

1 2 3 4 5 6 7 8

Response of LGDP to Shock LEXP

Response to Structural One S.D. Innov ations ± 2 S.E.

Preliminary results

Introduction Theory Method Results Conclusion 13

Figure 2. Structural Tax Revenue Shock

Quarter

Source: this study

-.02

-.01

.00

.01

.02

.03

.04

1 2 3 4 5 6 7 8

Response of LREV to Shock in LREV

-.04

-.02

.00

.02

.04

1 2 3 4 5 6 7 8

Response of LEXP to Shock in LREV

-.01

.00

.01

.02

1 2 3 4 5 6 7 8

Response of LGDP to Shock in LREV

Response to Structural One S.D. Innov ations ± 2 S.E.

Preliminary conclusions

• A positive government spending shock, have a positive effect on output, which last in

average eight quarters, afterwards goes down.

• An increase in tax burden, have a negative effect on output, this last in average three

quarter, then output return to its initial position as found in Ravnic & Žilić (2010), De

Castro & Hernández (2006).

• Findings also led to support the notion that robust institutions are key to long term

and sustained fiscal policy measures, as found in Lavigne (2006), Persson (2002),

Poterba (1994) .

Introduction Theory Method Results Conclusion 14

Thank you for your attention!

I also wish to acknowledge

and thank the following entities

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