|
|
Fiscal
Policies
Balanced-budget
options
The macroeconomic impact of public
sector deficits has been a source of considerable controversy in recent
years. In Discussion Paper No. 128 Research Fellow Willem Buiter
discusses this issue briefly, but focuses primarily on the effects of
balanced-budget fiscal policies.
Buiter considers the effects of fiscal policy in a small, open,
dependent economy, divided into two sectors, producing traded and
non-traded goods. The government purchases both traded and non- traded
goods, and it has the option of financing this spending by raising tax
revenues or by borrowing in an internationally integrated bond market.
There are two taxes available to the government: a lump-sum tax and a
tax on the production of traded goods. The government is assumed not to
finance its deficits by printing money, and its budgets are balanced, in
the sense that the outstanding public debt is a constant proportion of
GDP.
Buiter models individual private consumption behaviour taking account of
the uncertain lifetime of individual consumers. This uncertainty is an
important issue in fiscal policy analysis: it implies that individuals
discount the future more heavily than the government. As a result
private savings will not necessarily rise to reflect the increased
future tax liabilities implied by bond-financed fiscal deficits: after
all, the taxpayer may not be alive. The law of large numbers ensures
that this individual uncertainty has no effect on the total number of
future taxpayers, nor on the government's future tax base or discount
rate. In general, with uncertain lifetimes there will be no 'debt
neutrality' in the model: private consumption and investment will be
affected by the government's mixture and profile of taxation and
borrowing, for a given path of real public spending.
The production side of the economy is based on the 'dependent economy
model' of Wilson, Salter and Swan. Domestic wages and prices are assumed
to be flexible and the country is assumed to be a price-taker in world
markets. The terms of trade (the relative price of imports and exports)
are therefore exogenous.
Buiter considers the short- and long-run effects of such a
balanced-budget policy on the real exchange rate, the allocation of
production between the traded and non-traded goods sectors, private
consumption, and the current account and net external asset position of
the nation. He also considers how alternative budget-balancing rules
affect the economy's response to external shocks, such as a change in
the world rate of interest.
The real exchange rate (the relative price of traded goods to non-traded
goods) is the crucial relative price in Buiter's model. His analysis
suggests that in general balanced-budget fiscal policies will have
short-run, transitional and long-run effects on the real exchange rate.
Balanced budgets will also affect the current account in the short and
medium term and will have long-run effects on the nation's net foreign
asset position.
Buiter also investigates the effects of an increase in the tax rate on
traded goods. This tax increase tends to reduce consumers' real incomes:
in his model, the reduction may be so large that the reduced demand for
non-traded goods lowers the relative price (to producers) of non-traded
goods. Non-tradables production could contract and tradables production
expand in spite of the increase in the tax rate on traded-goods
production.
Buiter concludes that, there remain important fiscal policy choices
available to the government even when it is assumed that money financing
of deficits is not an option and budgets are balanced.
Structural and Stabilization Aspects of Fiscal and Financial Policy
in the Dependent Economy
Willen H Buiter
Discussion Paper No. 128,
September 1986 (IM)
|
|