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Monetary and Fiscal Management, Finance, and Growth. Thorvaldur Gylfason. Overview: Three parts. Implications of economic integration for monetary and fiscal policy Narrow focus on inflation as the main objective of monetary policy Inflation, finance, and growth - PowerPoint PPT Presentation
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Monetary Monetary and Fiscal and Fiscal ManagemeManagement, nt, Finance, Finance, and and GrowthGrowth
Thorvaldur Gylfason
Overview: Three partsOverview: Three parts
1.1. Implications of economic Implications of economic integration for monetary and integration for monetary and fiscal policyfiscal policy Narrow focus on inflation as the Narrow focus on inflation as the
main objective of monetary policymain objective of monetary policy
2.2. Inflation, finance, and growthInflation, finance, and growth Long-run goals of stabilizationLong-run goals of stabilization
3.3. Fiscal policy and growthFiscal policy and growth Long-run goals of allocation and Long-run goals of allocation and
distributiondistribution
Implications of Implications of economic integrationeconomic integration Monetary policyMonetary policy
Single currencySingle currency 12 out of 15, soon at least 22 out of 12 out of 15, soon at least 22 out of
2525 Concerns about common currency Concerns about common currency
despite different languages have despite different languages have subsidedsubsided
Number of official EU languages and Number of official EU languages and costs of translation are on the risecosts of translation are on the rise
Independent European Central Independent European Central Bank committed, by law, to Bank committed, by law, to low low inflationinflation Fundamental implications, of two Fundamental implications, of two
kindskinds
1
Implication of narrow Implication of narrow focus on inflationfocus on inflation New regime dictates narrow New regime dictates narrow
focus on focus on low inflationlow inflation as the as the main objective of monetary main objective of monetary policypolicy Inflation targeting, also outside Inflation targeting, also outside
EMUEMU Inflation depends on various Inflation depends on various
factors besides monetary policy factors besides monetary policy undertakings undertakings Fiscal policy, efficiency, Fiscal policy, efficiency,
institutions, etc. institutions, etc. After all, there are considerable After all, there are considerable
inflation differentialsinflation differentials within within EuropeEurope
Implication of narrow Implication of narrow focus on inflationfocus on inflation So, if ECB and, by extension, So, if ECB and, by extension,
national central banks are held national central banks are held responsible for maintaining low responsible for maintaining low inflation, they may need to inflation, they may need to reserve the right to address reserve the right to address allall sources of inflationsources of inflation How? Mainly through attempts at How? Mainly through attempts at
friendly persuasion, like U.S. Fedfriendly persuasion, like U.S. Fed This suggests a general This suggests a general
principle:principle: If it helps reduce inflation, the If it helps reduce inflation, the
Central Bank should support itCentral Bank should support it
Implication of narrow Implication of narrow focus on inflationfocus on inflation This is why central banks would This is why central banks would
be right to argue for be right to argue for more more competitioncompetition
Simple mechanismSimple mechanism Greater efficiency in resource Greater efficiency in resource
allocation imparts a boost to the allocation imparts a boost to the supply side, thereby putting supply side, thereby putting downward pressure on pricesdownward pressure on prices, , as ifas if demand had been reduceddemand had been reduced
Moreover, supply stimulus does not Moreover, supply stimulus does not have the same disadvantageous have the same disadvantageous side effects as side effects as demand restraintdemand restraint
Implication of narrow Implication of narrow focus on inflationfocus on inflation This is why I also think that This is why I also think that
central banks would be right to central banks would be right to criticize, e.g., the inefficiency of criticize, e.g., the inefficiency of the the CAPCAP
It is the same story:It is the same story: Increased efficiency stimulates the Increased efficiency stimulates the
supply side, thereby helping supply side, thereby helping contain inflation, at least for a contain inflation, at least for a whilewhile
Generally, central banks would be Generally, central banks would be right to support growth-friendly right to support growth-friendly reforms because reforms because growth helps growth helps restrain inflationrestrain inflation
Implication of narrow Implication of narrow focus on inflationfocus on inflation Some might object that a central Some might object that a central
bank involving itself in, e.g., the bank involving itself in, e.g., the macroeconomic consequences of macroeconomic consequences of agricultural policy could be agricultural policy could be accused of accused of political meddlingpolitical meddling
My answer is My answer is No, not reallyNo, not really Central banks have been granted Central banks have been granted
more independence precisely in more independence precisely in order to give them order to give them greater freedomgreater freedom to pursue the objectives assigned to pursue the objectives assigned to them by law to them by law
Increased Increased independence independence requires requires depolitizationdepolitization Newfound independence of Newfound independence of
central banks is a natural central banks is a natural extension of a long-standing extension of a long-standing depolitization processdepolitization process
Need independent, yet Need independent, yet accountable accountable Courts of lawCourts of law UniversitiesUniversities News mediaNews media And now, central banksAnd now, central banks What next? What next? Fiscal policy?Fiscal policy?
Should fiscal policy Should fiscal policy also be more also be more independent?independent? Begin by an example of Icelandic Begin by an example of Icelandic
fisheries managementfisheries management Intimately linked to fiscal policyIntimately linked to fiscal policy Resource rent amounts to 5% of Resource rent amounts to 5% of
GDPGDP Macroeconomic and fiscal concernMacroeconomic and fiscal concern Rather than giving the rents to boat Rather than giving the rents to boat
owners for free, government could owners for free, government could raise substantial revenue and reduce raise substantial revenue and reduce taxestaxes
Fish stocks are Fish stocks are common propertycommon property by by lawlaw
Objection: Objection: Politicians would Politicians would squander revenue from fishing feessquander revenue from fishing fees
Should fiscal policy Should fiscal policy also be also be moremore independent?independent? If so, the determination of fees If so, the determination of fees
and allocation of revenues could and allocation of revenues could be decoupled from the political be decoupled from the political process by setting up, yes, an process by setting up, yes, an independent independent Open Market Open Market Fisheries CommitteeFisheries Committee Thus, urgent fiscal reform can be Thus, urgent fiscal reform can be
assured, free from political assured, free from political interferenceinterference
Should this principle be applied Should this principle be applied more widely in the fiscal policy more widely in the fiscal policy sphere? sphere?
Should fiscal policy Should fiscal policy also be more also be more independent?independent? Fiscal policyFiscal policy belongs at national belongs at national
levellevel Yet, we have common rules Yet, we have common rules
involving involving numerical targetsnumerical targets in in Maastricht Treaty and Stability and Maastricht Treaty and Stability and Growth PactGrowth Pact
Do numerical targets call for Do numerical targets call for common standardscommon standards for fiscal for fiscal institutions? Laws governing fiscal institutions? Laws governing fiscal policy framework?policy framework?
Can budget discipline and fiscal Can budget discipline and fiscal efficiency be improved through efficiency be improved through delegationdelegation – i.e., depolitization? – i.e., depolitization?
Should fiscal policy Should fiscal policy also be more also be more independent?independent? Blinder’s Blinder’s Fiscal Policy Committee Fiscal Policy Committee
Vested with authority to determine Vested with authority to determine the the tax structuretax structure, but not the level , but not the level or composition of government or composition of government spendingspending
Need for (a) long-run perspective, Need for (a) long-run perspective, (b) freedom from special interest (b) freedom from special interest groups, (c) shorter decision lagsgroups, (c) shorter decision lags
Other proposals involve Other proposals involve debt limitsdebt limits Separate Separate stabilizationstabilization from from
allocationallocation and and distribution distribution – i.e., – i.e., depoliticize the stabilization depoliticize the stabilization function of fiscal policyfunction of fiscal policy
Should fiscal policy Should fiscal policy also be more also be more independent?independent? Basic idea here is this Basic idea here is this
National parliaments set the path – National parliaments set the path – i.e., i.e., medium-term targetsmedium-term targets – of – of government spending and taxes, government spending and taxes, based on allocation and based on allocation and distribution objectivesdistribution objectives
Fiscal policy committee determines Fiscal policy committee determines cyclical variationscyclical variations around that around that path, e.g., by setting individual tax path, e.g., by setting individual tax rates (such as VAT) or individual rates (such as VAT) or individual expenditure items (such as grants expenditure items (such as grants to regions)to regions)
Should fiscal policy Should fiscal policy also be more also be more independent?independent? But if so, why not depoliticize the But if so, why not depoliticize the
allocationallocation function of fiscal policy function of fiscal policy on similar efficiency grounds as on similar efficiency grounds as well? – including agricultural well? – including agricultural policy policy
But clearly, this argument But clearly, this argument cannot be taken too farcannot be taken too far We do not want to completely We do not want to completely
depoliticize politics, do we? depoliticize politics, do we? Like it or not, Like it or not, politics is necessarypolitics is necessary: :
let’s try to restrain it without let’s try to restrain it without stifling itstifling it
Distribution cannot be delegated!
Inflation, finance, and Inflation, finance, and economic growtheconomic growth Argument for decoupling Argument for decoupling fiscalfiscal
as well as monetary as well as monetary stabilizationstabilization from politics concerns the long from politics concerns the long runrun Inflation is perceived to be bad for Inflation is perceived to be bad for
long-run economic growthlong-run economic growth What is the evidence for this? What is the evidence for this?
What is the mechanism?What is the mechanism? Inflation hurts growth through Inflation hurts growth through XX
wherewhere XX can be saving, trade, finance, can be saving, trade, finance,
etc. etc.
2
From high inflation From high inflation viavia finance to slow finance to slow growthgrowth
Growth
Financial depth
Growth
Inflation
Financial depth
+ =Inflation
Let’s look at the financial linkage
What is the empirical evidence?
Financial depth and Financial depth and economic growtheconomic growth
-8
-6
-4
-2
0
2
4
6
0 20 40 60 80 100 120
Money and quasi-money 1965-98 (% of GDP)
Gro
wth
of
GN
P p
er
cap
ita 1
965-9
8, ad
juste
d
for
init
ial in
co
me (
% p
er
year)
r = 0.66
Japan
Switzerland
Jordan
Indonesia
Austria
87 countries
r = Spearman
rank correlation
Botswana
Inflation and Inflation and financial depthfinancial depth
87 countries0
20
40
60
80
100
120
0,00 0,20 0,40 0,60 0,80 1,00
Inflation distortion 1965-98
Mo
ney
an
d q
uas
i-m
on
ey 1
965-
98 (
% o
f G
DP
)
Brazil
NicaraguaArgentina
Austria
Switzerland
Japan
Add these two correlations,
and an inverse correlation
between inflation and
growth follows
r = -0.45
Inflation and Inflation and economic growtheconomic growth
Austria
However, the relationship However, the relationship between inflation and growth between inflation and growth turns out to be too complicated turns out to be too complicated to be discernible to the naked to be discernible to the naked eye as a two-dimensional eye as a two-dimensional correlationcorrelation
So, let us go the regression So, let us go the regression routeroute Estimate series of growth Estimate series of growth
regressionsregressions Same 87 countries during 1965-Same 87 countries during 1965-
19981998 Data from World Bank´s Data from World Bank´s WDIWDI
Inflation and Inflation and economic growtheconomic growth
Austria
Regress growth on inflation Regress growth on inflation distortion, defined as distortion, defined as /(1+ /(1+ ) ) where where is rate of inflation is rate of inflation
Then, test robustness by adding Then, test robustness by adding further explanatory variablesfurther explanatory variables Initial income, natural resourcesInitial income, natural resources InvestmentInvestment EducationEducation Population growthPopulation growth
Now, switch to Now, switch to EViewsEViews
DISTORT =
/(1+/(1+ ) )
Natural resource
curse
Conditional convergence
Investment is good for
growth …
… as is education, with
diminishing returns
Population growth hurts per
capita growth in medium
term
Inflation and Inflation and growth: growth: What is the What is the upshot?upshot?
Austria
High inflation hurts growthHigh inflation hurts growth An increase in inflation from 0% An increase in inflation from 0%
to 10% per year reduces per to 10% per year reduces per capita growth by more than capita growth by more than 0.15% per year0.15% per year Accords with existing studiesAccords with existing studies For comparison, per capita growth For comparison, per capita growth
was 1.3% per year in sample on was 1.3% per year in sample on averageaverage
Effects of inflation on growth are Effects of inflation on growth are economically significanteconomically significant
Inflation and Inflation and growth: growth: What is the What is the upshot?upshot?
Austria
Hence, if it is the need to Hence, if it is the need to immunize the immunize the stabilizing stabilizing function of monetary policyfunction of monetary policy from from political interference for long-political interference for long-term gain that has produced term gain that has produced independent central banks, then independent central banks, then ……
… … a similar argument can be a similar argument can be applied to the applied to the stabilizing role of stabilizing role of fiscal policyfiscal policy
If so, how about allocation and If so, how about allocation and distribution? distribution?
Now the plot thickens!
Fiscal policy and Fiscal policy and economic growtheconomic growth3 Let us now move from Let us now move from
stabilization to stabilization to allocationallocation and and distributiondistribution
The allocation role of The allocation role of government has important government has important consequences for consequences for long-run long-run growthgrowth EducationEducation Health careHealth care InfrastructureInfrastructure
Education Education and and economic growtheconomic growth Is education, like price stability, Is education, like price stability,
too important to be left to too important to be left to politicians? politicians?
Due to externalities, the Due to externalities, the government has a role to play in government has a role to play in educationeducation Without government involvement, Without government involvement,
not enough education would be not enough education would be provided in free markets, provided in free markets, thwarting social efficiencythwarting social efficiency
Even so, myopic governments Even so, myopic governments tend to devote too few resources tend to devote too few resources to educationto education
Open Market Education Open Market Education Committee?!Committee?!
Secondary-school enrolment and growth
87 countries87 countries-8
-6
-4
-2
0
2
4
6
0 50 100
Secondary-school enrolment 1980-97 (%)
Per
cap
ita e
co
no
mic
gro
wth
1965-9
8,
ad
juste
d f
or
init
ial in
co
me (
% p
er y
ear)
r = 0.72
Diminishing returns:
Additional benefit from
education becomes smaller
as enrolment increases
Austria
Nicaragua
Korea
Finland
Jamaica
Botswana
What is the empirical evidence?
Education is good for growth
Tertiary education Tertiary education 19981998 (% of cohort)(% of cohort)
0
10
20
30
40
50
60
70
80
Austria EU OECD USA
In education, Europe lags behind America
Education Education and and economic growtheconomic growth So, education is good for growth, So, education is good for growth,
but it tends to be but it tends to be undernourished in Europe undernourished in Europe compared with Americacompared with America
Perhaps delegation of authority Perhaps delegation of authority in education would better in education would better safeguard the long-run interests safeguard the long-run interests of the populationof the population One example of an allocation One example of an allocation
function of fiscal policy that could function of fiscal policy that could be delegatedbe delegated
Is Is health carehealth care also a candidate? also a candidate? Similar problems, but more difficultSimilar problems, but more difficult
Another candidate:
Pension reform
Distribution Distribution and and economic growtheconomic growth So, some part of allocation So, some part of allocation
function of fiscal policy could, in function of fiscal policy could, in principle, be delegated – that is, principle, be delegated – that is, depoliticizeddepoliticized
Not the Not the distribution functiondistribution function, , however, which is however, which is inherently inherently politicalpolitical Even so, distribution seems to Even so, distribution seems to
matter for long-run growthmatter for long-run growth What is the evidence? What is the evidence? What are the mechanisms? What are the mechanisms?
Inequality and economic growth
What is the empirical evidence?
-8
-6
-4
-2
0
2
4
6
0 20 40 60 80
Gini coefficient (various years)
Per
cap
ita
eco
no
mic
gro
wth
196
5-98
, ad
just
ed f
or
init
ial i
nco
me
(% p
er y
ear)
75 countries75 countries
A 1212 point increase
in Gini coefficient
goes along with a
decrease in per
capita growth by
1%1% per year
r = -0.50
Korea
Brazil
Sweden
Austria
South Africa
France
Mechanisms:Social cohesionEducation
No sign that
excessive equalization
hurts growth
ConclusionConclusion4 These slides can be viewed on
my website:
www.hi.is/~gylfason
The EndThe End Distribution belongs in political Distribution belongs in political
arena, even if it matters for arena, even if it matters for growthgrowth
Distributional implications of Distributional implications of education and, especially, health education and, especially, health care complicate delegation of care complicate delegation of these key allocation roles of these key allocation roles of fiscal policy fiscal policy
Even so, some degree of Even so, some degree of delegation beyond mere delegation beyond mere monetary stabilization may be monetary stabilization may be worth consideringworth considering
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