Fiscal%20Policy%20and%20Public%20Expenditure%20Santiago%20Herrera - PowerPoint PPT Presentation

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Fiscal%20Policy%20and%20Public%20Expenditure%20Santiago%20Herrera

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Title: Fiscal%20Policy%20and%20Public%20Expenditure%20Santiago%20Herrera


1
Fiscal Policy and Public ExpenditureSantia
go Herrera
  • PUBLIC EXPENDITURE ANALYSIS AND MANAGEMENT COURSE
  • March 2005

2
Outline
  • I. The Governments budget identity
  • II. Expenditure composition, efficiency and
    growth impact
  • III. Taxes and growth-optimal size of the
    expenditure
  • IV. Financing the budget-debt sustainability
    analysis in practice
  • V. Policy coordination fiscal, monetary,
    exchange rate and public debt policies

3
I. The Governments Budget Identity
Uses Sources
Uses
Sources
4
Governments Inter-temporal Budget Constraint
Todays debt stock NPV of (primary surplus
seigniorage revenue)
where
5
II. Public spendingcomposition, efficiency, and
growth impact
  • Objectives of public expenditure
  • Efficiency in resource utilization
  • Economic growth
  • Equity of income distribution and social
    stability
  • Cost-Benefit analysis
  • Measuring effciency
  • Growth impact

6
A. Costs Benefits Analysis
  • Rationale for public intervention
  • Redistribute income
  • Correct market failure/positive externality
  • Greater supply of goods than private-sector
    provision
  • Objectives and Targets
  • Valuing costs
  • Additional fiscal burden
  • Source of funds to cover costs borrowing vs.
    taxation
  • Marginal cost of public funds
  • Sustainability Macroeconomic Stability
  • Valuing benefits
  • Comparing with a counterfactual

7
Net present value of geothermal project in the
Philippines with different marginal cost of funds
8
BOX 2 ROAMEF CYCLE
Source The Green Book, HM Treasury
9
B. Measuring Efficiency of Public Spending
  • Nonparametric Approaches (Deterministic or
    Stochastic)
  • FDH (Free Disposable Hull)
  • DEA (Data Envelopment Analysis)
  • Parametric Approaches (Deterministic or
    Stochastic)
  • Corrected OLS
  • Stochastic Frontier

10
Parametric Approach Stochastic Frontier - An
Illustration
11
Methodology Concept of Efficiency
  • Technical Efficiency TE OR/OP
  • Allocative Efficiency AE OS/OP

12
Methodology FDH
  • Input Efficiency for country B XA/XB
  • Output Efficiency for country B YB/YA

13
Non-parametric Approach FDH An Illustration
14
Methodology DEA
  • Country C Efficient by FDH, but inefficient by
    DEA
  • Peers of country C A and D
  • Country D inefficient by CRS DEA, but efficient
    by VRS DEA

15
DEA Efficient Frontier Primary Enrollment
16
An important factor of production (public
spending) is used more intensively in the
relatively richer countries
Public Expenditure on Education and GDP per
capita (both in logs)
17
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18
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19
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20
C. Public Expenditure Composition and Growth
  • Question Whats impact of public spending
    composition on growth?
  • Re-allocation decisions among Infrastructure,
    Education, Health, and Transfers
  • Financing decisions for expenditure change debt
    or tax, or or different types of tax instruments
  • Permanent vs. transitory expenditure changes

21
Modeling approach
  • Question Effect of public expenditure on growth
  • Building blocks of the model economy based on
    some principles that allow replication of key
    features (growth, transfers, debt accumulation)
  • Experiments
  • a. Allocation decisions Change compositions and
    compare with SS
  • b. Financing decisions debt vs. taxes or
    different types of tax instruments
  • c. Permanent vs. transitory expenditure changes

22
Building blocks
  • Preferences (types of agents, consumption,
    unproductive government expenditure)
  • Technology- Explicit relationship between inputs
    and output productive government expenditure)
  • Resource constraints (public and private sectors)

23
Building blocks (Glomm-Rioja)Preferences
  • Consumers utility maximization problem

Solution leads to optimal savings and labor
supply decisions.
24
Building blocks -Technology
25
Building blocks-productive government expenditure
  • Human capital production function

Laws of motion
26
Building blocks-Fiscal policy
  • where public expenditure (as of GDP)
  • on infrastructure
  • on education
  • on transfers
  • on other non-utility enhancing public service
  • Tax rate
  • on labor income
  • on capital (interest) income

27
Building blocks- The steady state
  • Competitive equilibrium conditions
  • The household utility maximization problem is
    solved.
  • The representative firms profits maximization
    problem is solved.
  • The government budget constraint is satisfied.
  • The goods market clears
  • The competitive input markets clear

28
Permanent increase in expenditure financed by
debt
29
Temporary increase in expenditure financed by
debt
30
Permanent increase in expenditure financed by
tax
31
Income per capita - Permanent Expenditure
Reallocation (1 of GDP)
Income in base year 4500 for Brazil, constant
1995
32
III. How much government expenditure? a simple
model and international comparison
  • The model (Barro and Sala-I-Martin, 1995)
  • Production function of the economy
  • Yt AtF(K, N, G) or YAL1-?K?G1-?
  • Government Budget constraint G?Y
  • Representative individual maximizes a utility
    function subject to a budget restriction

33
Public expenditure has two opposite effects on
growth rate of consumption of
  • One positive effect derived from larger
    government services
  • One negative effect due to the after-tax marginal
    product of capital

34
The simple estimate of the optimal size of
government expenditure
g
?
35
From this simple model we obtain
  • The maximum growth rate is achieved for
  • ? G/Y1-?
  •   Indicators of productiveness or
    unproductiveness of government services
  • ( dy/dggt0 ?)
  • The degree of over-provisioning or under-
    provisioning of public capital
  • Atf1lt rdn

36
Implications of Maintenance in Public Capital
  • Aggregate Production YAL1-?K?G1-?
  • Private capital
  • Public capital
  • Maintenance expenditure
  • New public investment
  • Government Budget constraint
  • ? Optimal tax rate that maximizes growth

37
Does government expenditure (as a ratio to
revenue) conform to international experience?
38
The same holds when private investment is used as
a metric
39
The ratio between capital and current
expenditures. Expenditure composition is a
matter of concern
40
IV. Debt sustainability and productivity of
capital expenditures
  • The traditional debt dynamics equation
  1. Debt targeting- S instrument of fiscal policy
  2. Fiscal space-productivity of public capital

41
Revised debt dynamics equation, with current and
capital expenditures disaggregated
rd rental price of public capital p marginal
productivity of public capital
42
Policy coordination fiscal, monetary, exchange
rate and public debt management- fiscal space
considerationsunder liquidity constraints-Brazil
2002
  • Features of Brazilian public debt
  • Mostly domestic
  • Short maturity and duration
  • Indexed to the exchange rate or to short term
    interest rates (Selic)
  • Concentrated holders (mutual funds, few banks)

43
Public debt jumps in 2001 as currency depreciates
(Argentina crisis unfolding)
44
The primary surplus falls. The presidential
campaign is no fertile ground for fiscal
adjustments.
  • Primary Fiscal Balance of the Public Sector
    2000-2003
  • (as a percentage of GDP)


45
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46
Public debt sustainability concerns causes a run
on mutual fund deposits

47
The central bank was forced to print money to
redeem public debt
48
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49
Exchange rate and interest rates adjust after
the fiscal commitment is certain.
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