Dennis P. J. Botman

A New-Open-Economy-Macro Model for Fiscal Policy Evaluation

We develop a New-Open-Economy-Macro model in which Ricardian equivalence does not hold because of (i) distortionary labor and corporate income taxation; (ii) limited asset market participation; and (iii) because the overlapping-generations structure results in a disconnect between current and future generations. We consider a permanent increase in government debt following a cut in labor or corporate income taxes in a small and large open economy. We analyze the sensitivity of the results to the key structural parameters of the model and argue that under plausible assumptions there will be significant crowding-out effects associated with permanent increases in government debt.

Fundamental Determinants of the Effects of Fiscal Policy

We explore the underlying determinants of the macroeconomic effects of fiscal policy and tax and social security reform using the Global Fiscal Model (GFM). We show that the planning horizon of consumers, access to financial markets, and the elasticity of labor supply, as well as the characteristics of utility and production functions, and the degree of competition are all critical for determining the impact of fiscal policy. Four topical fiscal policy issues, for a representative large and small economy, are examined: the effects of changes in government debt; higher government spending; tax reform; and privatization of retirement savings.

DSGE Modeling at the Fund: Applications and Further Developments

Researchers in policymaking institutions have expended significant effort to develop a new generation of macro models with more rigorous microfoundations. This paper provides a summary of the applications of two of these models. The Global Economy Model is a quarterly model that features a large assortment of nominal and real rigidities, which are necessary to create plausible short-run dynamics. However, because this model is based on a representative-agent paradigm, its Ricardian features make it unsuitable to study many fiscal policy issues. The Global Fiscal Model, which is an annual model that uses an overlapping-generations structure, has been designed to analyze the longer-term consequences of alternative fiscal policies.

The Curious Case of the Yen as a Safe Haven Currency: A Forensic Analysis

During risk-off episodes, the yen is a safe haven currency and on average appreciates against the U.S. dollar. We investigate the proximate causes of yen risk-off appreciations. We find that neither capital inflows nor expectations of the future monetary policy stance can explain the yen’s safe haven behavior. In contrast, we find evidence that changes in market participants’ risk perceptions trigger derivatives trading, which in turn lead to changes in the spot exchange rate without capital flows. Specifically, we find that risk-off episodes coincide with forward hedging and reduced net short positions or a buildup of net long positions in yen. These empirical findings suggest that offshore and complex financial transactions should be part of spillover analyses and that the effectiveness of capital flow management measures or monetary policy coordination to address excessive exchange rate volatility might be limited in certain cases.

Investment Incentives and Effective Tax Rates in the Philippines: A Comparison with Neighboring Countries

This paper compares the general tax provisions and investment incentives in the Philippines to six other East Asian economies – Malaysia, Indonesia, Lao, Vietnam, Cambodia and Thailand. It finds that general effective tax rates are relatively high in the Philippines, while investment incentives are comparable to those in neighboring countries. Tax holidays are most attractive for very profitable firms, creating redundancy, and for investment in short-lived assets. Two recently proposed tax reforms would replace tax holidays by a reduced corporate income tax rate or a low tax on gross receipts. The results suggest that this would result in stronger incentives to invest, while government revenue would increase. Alternatively, replacing tax holidays with a general reduction in the corporate tax rate and accelerated depreciation would either not provide the same incentives or be very costly.

Strategies for Fiscal Consolidation

Japan’s key fiscal challenge is to put public finances on a more sustainable footing. Large government budget deficits have boosted Japan’s net public debt to over 85 percent of GDP, one of the highest in the Organization for Economic Cooperation and Development (OECD) (Figure 4.1). In the years ahead, rising health and elderly care costs will add strain to public resources. The Cabinet Office estimates that in the absence of further policy adjustments, social security expenditure will reach 22 percent of GDP by 2025, up from about 18 percent of GDP in 2005.1 As a result, the government’s net debt could continue to rise. Rising debt could increase interest rates, lower investment, and ultimately hamper growth in the context of population aging.

Options for Fiscal Consolidation in the United Kingdom

This paper examines the macroeconomic effects of different timing and composition of fiscal adjustment in the United Kingdom using the IMF’s Global Fiscal Model. Early consolidation dampens aggregate demand in the short term, but increases output in the long term as smaller primary surpluses are needed as a result of lower interest payments. Reducing government transfers or current government spending provides larger gains than increasing taxes, in particular compared to raising corporate or personal income taxes. We show that these conclusions are robust under alternative behavioral assumptions and parameterizations. A reduction in global saving would make early consolidation more urgent from both cyclical and long-term perspectives. Finally, we show that tax reform aimed at increasing incentives to save could provide support to fiscal consolidation measures.

Policy Challenges of Population Aging in Ireland

The projected rise in age-related government spending as a share of GDP in Ireland over the next forty years is among the highest in the euro area. In the absence of reforms, public debt will increase to unsustainable levels. This paper uses the IMFs Global Fiscal Model to compare the macroeconomic effects of different fiscal strategies to accommodate the rise in age-related spending. The simulations suggest that adopting a package of measures, including an increase in the retirement age, broadening the tax base, and raising indirect taxes, would be a more growth-friendly strategy than relying exclusively on raising the social security contribution rate.

Is Japan’s Population Aging Deflationary?

Japan has the most rapidly aging population in the world. This affects growth and fiscal sustainability, but the potential impact on inflation has been studied less. We use the IMF’s Global Integrated Fiscal and Monetary Model (GIMF) and find substantial deflationary pressures from aging, mainly from declining growth and falling land prices. Dissaving by the elderly makes matters worse as it leads to real exchange rate appreciation from the repatriation of foreign assets. The deflationary effects from aging are magnified by the large fiscal consolidation need. Many of these factors will beset other advanced countries as well, but we find that deflation risk from aging is not inevitable as ambitious structural reforms and an aggressive monetary policy reaction can provide the offset.

Macroeconomic Management When Policy Space is Constrained; A Comprehensive, Consistent and Coordinated Approach to Economic Policy

The recovery in GDP growth since the global financial crisis has been halting and weak. Concern is widespread that countercyclical policies have run out of space or lack the power to raise growth or deal with the next negative shock. This note argues that room exists for effective policies and that it should be used if appropriate. The most promising route involves a comprehensive, consistent, and coordinated approach to policy making. Comprehensive policy actions within a country exploit synergies, making the whole greater than the sum of parts. Consistent policy frameworks anchor long-term expectations while allowing decisive short- to medium-term accommodation whenever necessary. Coordinated policies across major economies amplify the helpful effects of individual policy actions through positive cross-border spillovers. The findings of this paper indicate that policy coordination adds particular value if the current approach falls short of reviving growth, or in the event of a further downward shock.