Gabriella Legrenzi

Nonlinearities and the Sustainability of the Government's Intertemporal Budget Constraint

We analyze the sustainability of the governments intertemporal budget constraint and the corresponding fiscal reaction function within a nonlinear error‐correction framework. Our empirical analysis, based on Italy, provides some evidence that the Italian government is meeting its intertemporal budget constraint. Nevertheless, we show that the burden of correcting budgetary disequilibria is entirely carried out by changes in the average tax rate, with a weakly exogenous government spending, possibly determined by the political process. We also document some rigidities of the tax instrument, in terms of downward inflexibility of the average tax rate with respect to its long‐run level. Finally, we provide some evidence in favor of a nonlinear adjustment toward a sustainable long‐run equilibrium, as the average tax rate adjusts faster the further away it gets from the equilibrium. By considering the behavior of taxes across the economic cycle, we also provide some evidence of inflexibility of the tax instrument during bad times.

The Role of Omitted Variables in Identifying a Long-run Equilibrium Relationship for the Italian Government Growth

We discuss the role of omitted variables in the long run empirical modeling of the Italian government growth based on a Wagners Law framework. We identify a non-spurious long-run relationship between general government expenditure and domestic product only when our Wagners Law model is enhanced by a measure of bureaucratic power, as a supply-side variable, and by the ratio of local to state expenditure, as an institutional factor that captures the division of competencies between local and central government in allocating public expenditure. This result is independent from the Wagners Law specification chosen. The persistence profile analysis shows a slow adjustment to equilibrium for the estimated government growth relationship following system-wide shocks, pointing to rigidities and complex functioning of the public sector.

The displacement effect in the growth of governments

We analyze the displacement effect within a multivariaterevenue-expenditure model of government growth, based on along historical dataset, for Italy. Our long-run analysisshows a permanent influence of domestic product on the growthof governments, supporting Wagners law. The short-rundynamics are more complex and provide some evidence for thedisplacement effect, in terms of a lower resistance againsttax-financing of government spending in the post-war. Inaddition, government spending adjusts faster when deviationsfrom its equilibrium get larger.

A Multivariate Approach to the Growth of Governments

The Italian general government expenditure is empirically modeled by considering demand-side, supply-side, and institutional factors. The authors estimate a long-run relationship with government expenditure driven by the demand-side and supply-side effects of domestic income and bureaucratic power, respectively, as well as by an institutional factor, namely, the decentralization of public expenditure. The disequilibrium error positively affects income growth and local spending, implying that when government expenditure is above its equilibrium level, both economic growth and local governments benefit. However, tighter government spending within the European Monetary Union environment suggests that local governments will have to become more efficient to find additional resources for their financing.

COMMERCIAL ACTIVITY AS INSURANCE: THE INVESTMENT BEHAVIOUR OF NON‐PROFIT ORGANIZATIONS

We provide a new explanation for commercial activities by non-profit organizations whose primary concern is to supply mission output. Starting from the observation that donations to individual non-profits are often highly volatile, we show how investment in commercial activity can constitute a form of insurance for mission activity. Although investment in commercial activity has an opportunity cost in terms of capacity to produce mission output, if donations turn out to be low the commercial revenue will enable cross-subsidization of mission output. The equilibrium commercial investment is (weakly) positively related to the degree of risk aversion.

Non-linear Real Exchange Rate Effects in the UK Labour Market

Using UK data over the 1973q1-2004q1 period, we find that the dynamics of the real exchange rate, real wages and unemployment vary both with large versus small real exchange rate disequilibria and rising versus falling unemployment regimes. The short-run real exchange rate adjusts only when large disequilibrium deviations occur. We report fast real exchange rate adjustment in periods of falling unemployment. This implies that prices and wages are more flexible when real output is high. When the real exchange rate is highly undervalued, workers respond to an improvement in domestic competitiveness by demanding and getting higher wages. Unemployment is reduced following gains in competitiveness when the real exchange rate is further away from equilibrium.

Beyond the demand: the importance of supply-side and institutional factors in the growth of governments

Traditional empirical studies on the growth of government focus on the demandside, or, alternatively, build multivariate models based on several possible explanations. The demand-side alone has difficulty explaining the growth of government, on the other hand, multivariate estimates have the drawback that, given the scarce availability of time-series observations on public expenditure, they have low degrees of freedom. The method of analysis proposed here consists of considering a parsimonious model that includes the supply-side and the institutional framework as further explanatory variables for the growth of government. Empirical testing for Italy shows the existence of a long-run relationship between general government expenditure and domestic product only when the proposed model is enhanced by a measure of bureaucratic power and by an institutional factor that captures the division of competencies between local and central government in allocating public expenditure.

Commercial activity as insurance: the investment behavior of non-profit firms

We provide a new explanation for commercial activities by non-profit organizations whose primary concern is to supply mission output. Starting from the observation that donations to individual non-profits are often highly volatile, we show how investment in commercial activity can constitute a form of insurance for mission activity. Although investment in commercial activity has an opportunity cost in terms of capacity to produce mission output, if donations turn out to be low the commercial revenue will enable cross-subsidization of mission output. The equilibrium commercial investment is (weakly) positively related to the degree of risk aversion.

COMMERCIAL ACTIVITY AS INSURANCE: THE INVESTMENT BEHAVIOUR OF NON-PROFIT ORGANIZATIONS: COMMERCIAL ACTIVITY AS INSURANCE

We provide a new explanation for commercial activities by non-profit organizations whose primary concern is to supply mission output. Starting from the observation that donations to individual non-profits are often highly volatile, we show how investment in commercial activity can constitute a form of insurance for mission activity. Although investment in commercial activity has an opportunity cost in terms of capacity to produce mission output, if donations turn out to be low the commercial revenue will enable cross-subsidization of mission output. The equilibrium commercial investment is (weakly) positively related to the degree of risk aversion.