Julia Lendvai Laurent Moulin - PowerPoint Presentation

Slide1

Julia LendvaiLaurent MoulinAlessandro TurriniDG ECFIN, European Commission

From CAB to CAAB?

Correcting indicators of structural fiscal positions for current account imbalances

MotivationBefore the crisis, a number of EU countries have witnessed absorption booms and growing current account deficits as a result of falling risk premia and rapid financial integration. At the same time, fiscal policy in those same countries has not been leaning against the wind effectively so as to contain boom-bust dynamics. This analysis shows that standard approaches

for adjusting budget balances for the cycle could miss part of the temporary revenues accruing during absorption booms

Illustrates a methodology to correct government budget balances for temporary elements linked both to

output cyclicality and to absorption booms (CAAB)

Uses DSGE models to assess the implications of

tageting

the CAAB during absorption booms for output stabilisation and the accumulation of external imbalances

Absorption booms, current account, fiscal policy

Absorptiom booms, current account, fiscal policySome stylised facts:Current accounts deteriorate during absorption booms, improving afterwards;Government budget balance improves during the boom, falling afterwards;CAB broadly constant during the boom, falling afterwards;Strong growth of indirect revenues/GDP during the boom ;

Apparent revenue

elasticities

growing

during

the boom,

falling

afterwaeds

Linking current accounts and structural indicators of fiscal policy (I)CAB approach assumes that revenues are linked to outputWhile this is the case for direct taxes, indirect taxes are levied on imports but not on exports, i.e., they are linked to absorptionFor the above reason, and since output and absorption are imperfectly correlated, the CAB may miss temporary cyclical components of the budget during absorption booms and busts

Linking current accounts and structural indicators of fiscal policy (II)The CAB is built on a well-known benchmark for computing structural revenues and expenditures, i.e., output equal to potentialAn equally obvious candidate is not available for defining a benchmark for absorptionApproach taken: link benchmarks for absorption to benchmarks for current accounts.

C

urrent account balances in line with fundamentals (“current account norms”).

From CAB to CAABCABt = (b/y)t – λ

ygap

t

CAAB

t

=

(

b/y

)

t

–

β

t

ygap

t

–

γ

t

agap

t

,

β

t

=

λ

t

-γ

t

.

agap

t

=

[(

a

t

– a*

t

)

/y*

t

]

,

a*

t

= y*

t

– ca*

t

+

it

t

.

From CAB to CAABThe current account norm ca* is estimated following the approach developed in Chinn and Prasad (2004) and by the IMF CGER (Lee et al., 2008). Prediction from pooled cross-section/time series regressionsSample: 60 advanced and emerging economies, 1970-2010Specification: General government budget balance/GDP ratio (+) Old-age dependency ratio (-)Real GDP per capita at PPP (+)

Real GDP per capita growth (-)

Net foreign asset/GDP ratio (+)

Oil balance (+)

Does CAB or CAABmake a difference? (I)

Difference between CAAB and

CAB,

selected

euro-area

countries

(

percent

of

GDP)

Does CAB or CAABmake a difference? (II)

Difference between CAAB and

CAB

for

selected New Member

States

(

percent

of

GDP)

Does CAB or CAAB make a difference? (III)

Difference between CAAB and

CAB

for

selected New Member

States

NFA-stabilisation approach

(

percent

of

GDP)

Does targeting the CAABmake a difference? (I)DSGE model simulations help assessing the extent to which targeting the CAAB rather than the CAB can make a difference

for fiscal prudence and

preventing

imbalances

Simulation

with

QUEST III

Model set up

Small open

economy

,

fixed

XXR

C

alibrated

to

average Baltic economy

Shocks

A): Baseline: 500

bp

.

reduction

in

risk

premium

in

2001

B): A)+ CAB=0

since

2005 (max 4% GDP)

C): A) + CAAB==0

since

2004 (max 7% GDP)

Does targeting the CAABmake a difference? (II)

Targeting CAB or CAAB balance during absorption booms: DSGE model simulations

Concluding remarksThe standard EU method for adjusting budget balances during the cycle may miss some temporary revenue components during absorption boom and busts A relatively straightforward modification of the CAB that also takes into account the fact indirect taxes are linked to absorption (CAAB) could be a useful counter-check in assessing the structural fiscal position of countries Taking into account the link between temporary revenues and absorption in constructing indicators for structural fiscal balances would contribute to Fiscal prudence during absorption booms

strengthening the contribution of the fiscal balance in preventing external imbalances