Merih Uctum

Debt and Deficit Ceilings, and Sustainability of Fiscal Policies: an Intertemporal Analysis

In this paper, we examine the likely consequences for the sustainability of fiscal policy of pursuing goals that rely on restrictive ceilings on deficits and debt. We provide a formal theoretical framework for analyzing the sustainability of fiscal policy based on the government intertemporal budget constraint and derive conditions that determine whether a given fiscal stance is sustainable. This framework generalizes the existing literature in several important respects. We allow for time-varying interest rates, for the primary deficit to be endogenous, for a finite planning horizon suitable for medium-term policy making, for possible future policy shifts, we show how published forecasts can be used and we provide a measure of fiscal pressure. We then apply this analysis to the fiscal positions of the United States and the European Union countries since 1970 and to their planned positions over the next decade. We find that many countries do not have a sustainable policy. The evidence in favor of sustainability is strengthening for most countries when the data are extended to incorporate future fiscal consolidation plans, reflecting the general shift toward fiscal austerity in recent years. In contrast, with a finite horizon we show that the recent policy shift made the paths of future policies sustainable. However, imposing ceilings on debt or deficit-to-GDP ratio throws most economies onto an unsustainable path unless governments undertake a major tax or expenditure adjustment. High-debt countries can satisfy the 60 percent debt rule by 1999 only by raising (reducing) the average tax (spending) rate substantially for five years. A 3 percent plan 1999 or a zero-deficit plan by the year 2002, puts an increasingly high pressure on most economies, including the United States, requiring a gradual rise (decline) in the tax (spending) rate.

The sustainability of current account deficits: A test of the US intertemporal budget constraint☆

Abstract This paper proposes a new method of determining whether a country is likely to be able to sustain its current account deficits without defaulting on its debt. It is based on the notion of the national intertemporal budget constraint (IBC) which is derived from a forward solution of the balance payments identity. Although the problem is formally similar to that considered in the literature on the government IBC, a more general solution is obtained by allowing the primary deficit to be endogenous instead of exogenous. It is shown that the existence of negative feedback from net indebtedness to the primary deficit - a wealth effect - is sufficient. This method supplants the ad hoc approach previously adopted in the current account literature. Whilst many of the same variables appear, a formal structure for analysing them is provided.

An Investigation of Current Account Solvency in Latin America Using Non Linear Stationarity Tests

Using a new methodology that allows for nonlinearities, we find frequent support for sustainability in the debt of a set of Latin American countries. Our findings overturn results obtained with traditional unit-root tests and provide a more realistic alternative to evaluate the external solvency of an economy.

European integration and asymmetry in the EMS

The empirical literature offers conflicting views of German dominance in the European Monetary System. We examine the validity of the German dominance hypothesis (GDH) by analyzing the responses of the European central banks and the money markets to monetary innovations originating both in Europe (European asymmetry) and abroad (international asymmetry). Our results reconcile the conflicting views in the literature. The GDH is confirmed when the analysis is conducted with intervention rates before the German unification. Results support European asymmetry with short rates before 1990 but not international asymmetry. After 1990 the GDH is not supported by either set of rates.

A CRITICAL EVALUATION OF EXCHANGE RATE POLICY IN TURKEY

Abstract This paper reviews and critically evaluates the exchange rate policy followed in Turkey in the post-1980 period during which a far-reaching program of liberalization has been launched. We conclude that the new exchange rate policy has been essential for Turkeys regaining its creditworthiness. Furthermore, it has positively contributed to growth of output and exports, and to expansion of tradables production relative to nontradables. Persistence of inflation and weakness of private investment in tradables overshadow the successes recorded in other areas, and cast doubt over the sustainability of Turkeys outward orientation. We argue that the root cause of these problems has been inconsistencies between overall economic policies, rather than the exchange rate policy itself. We compare the period of real appreciations since late 1998 with the earlier period of real depreciations, and draw policy implications.

Public Debt, the Unit Root Hypothesis and Structural Breaks: A Multi-Country Analysis

We assess fiscal performances in G7 and selected Latin American and Asian countries. We consider two questions: (i) Have public finances been sustainable? (ii) Do countries follow more restrictive fiscal policies when debt starts to rise? We find that: (i) the traditional unit root tests often overlook the corrective actions taken by many governments; controlling for structural breaks changes the non-stationarity results dramatically among the three groups; (ii) estimation of a reaction function for governments, expanded by incorporating structural breaks, provides further evidence for significant active anti-debt policies among G7 countries, and to a lesser extent in the other regions.

Nonlinear Alternatives to Unit Root Tests and Public Finances Sustainability: Some Evidence from Latin American and Caribbean Countries

We analyse the sustainability of government debt for Latin American and Caribbean countries employing unit-root tests with nonlinear alternative hypotheses and examine the robustness of our results against those from unit-root tests with breaks and threshold nonlinearities. We show that, in general support for sustainability substantially improves when nonlinear mean reversion is taken into account. We also find that the results obtained from applying various tests with nonlinear alternatives, although broadly consistent, are not identical. This suggests that reliance on a single unit-root test for assessing fiscal policy sustainability may be misleading. Copyright (c) Blackwell Publishing Ltd and the Department of Economics, University of Oxford, 2008.

Why Have Corporate Profits Declined? An International Comparison

The paper compares the trends and determinants of US profits with those of Japan, Germany, and Canada in a model of pricing-to-market in the export and domestic markets. It is found that during the 1970s increasing unit production costs lowered profits in all countries. After 1980, cost factors still affected profits except in the USA where lower real import prices depressed profits. It is shown that a currency appreciation hurts US profits three times more than Japanese profits via the imported inputs channel. This finding may explain why an overvalued currency is sustainable for a longer period in Japan than in the USA. Copyright 1998 by Blackwell Publishing Ltd.

Pricing-to-Market: the Japanese Experience with a Falling Yen and the Asian Crisis

The paper examines whether Japanese exporters changed their strategic pricing behavior as a result of the profit squeeze of the late 1980s. It shows that shocks such as the end-of-bubble, the prolonged yen depreciation, and the Asian crisis affected export prices. These effects, however, are too small to change the long-run equilibrium relation between sectoral export prices and their determinants. In particular, results suggest that Japanese exporters are not using the depreciation of the yen to gain market share.

Decline in the US profit rate: a sectoral analysis

The profit rate is a key element in the cyclical growth of economies because of its effect on investment and saving behaviour and, therefore, on capacity, productivity and competitiveness. The US industry profit rates have declined dramatically since the 1950s. This decline is analysed and the factors that explain it are determined. It is found that sectoral factor productivities and real factor prices account for most of this decline. The real wage has a stronger effect on manufacturing profit rates, while the real capital price explains better profitability in nonmanufacturing industries. A rise in both factor prices reduces the profit rates during the 1960s and the 1970s. After 1980, a fall in the real price of capital with a sustained improvement in technology account for the stabilization of the declining trends in sectoral profit rates. Breaking with the trends in other industries, technology accounts for most of the decline in the finance, insurance and real estate sector throughout the sample.