Discussion ofPolicy Volatility, Institutions and

Economic GrowthBy Antonio Fatás and Ilian Mihov

By Vicente TuestaCentral Bank of Perú

March, 2006

Motivation Institutions versus Discretionary Macroeconomic

Policies

Standard view: good macroeconomic policies are the cause of increased stability.

AJRT (2003) Bad macroeconomic policies are just the symptoms of weak institutions (key instrument to shape current institutions…..mortality rate).

What do the authors do? Re-evaluate whether macroeconomic

policies matter for economic performance.

Evaluate causal effect from institutions to fiscal policy volatility

How? They construct a measure that captures

the exogenous component of fiscal stance.

What do they find? Fiscal policy volatility affects growth

negatively (a significant direct effect)

Institutions are important to the extent that they shape policy outcomes (40%)

Comment I: Exogeneity of fiscal Stance Sample of coutries: Developing economies have less

room to be countercyclical, therefore larger volatility during crises. Larger volatility in developing countries, institutions might be less informative....

Institution is a highly persistent state variable. Growth is very disperse across countries as it is

volatility. Therefore: volatility of might be a good

candidate to have an effect on growth. What about the level of the shocks? Large errors are

the driving forces!! Reduced form estimation. Some general equilibrium

story is needed.

t

Comment II: What else can explain fiscal policy volatility? Institutions are just a part of it (for the

whole sample of countries)

A country’s capacity to absorve other shocks (i.e. terms of trade shocks, foreign interest rate shocks)

Comment III: Non lineal effects If discretionary fiscal policy is important,

how much discretion is optimal? Which level of fiscal policy volatility is good?

Developed and developing countries must have different threholds of fiscal volatility.

Comment IV: Channels of transmission Policy volatility: Investment

But, this is not the case for rich countries.

Puzzle, given the link between policy volatility and growth.

Risk-Sharing is easier in rich countries than in developing countries.

Financial integration might help developing countries.

Comment V: Another channel Fiscal volatility is associated to demand shocks.

What about supply shocks?

Kydland and Prescott (1982): TFP explains great part of macro volatility

Technological adoption might be significantly linked to institutional variables (i.e. barriers such as legal constraints). I guess its omission is not neutral to the analysis.

yttt gAI 1

Growth in Perú

Perú 1950-2005

0%

1%

2%

3%

4%5%

6%

7%

8%

9%

10%

-3% -2% -1% 0% 1% 2% 3% 4%

Tasa de Crecimiento Promedio

Vol

atil

idad 90´s

70´s

2000´s

50´s60´s

Negative relationship

Macro Stability is needed

Fiscal Policy

Resultado Primario (porcentaje del PBI)

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

Media Desviación Estándar

1980-1993 1994-2004

Primari deficit: less pro-cyclical and less volatile during

Monetary PolicyCorrelaciones entre las tasas de interés en t+i y PBI en t

(1995.4:2001.4)

-1.0

-0.5

0.0

0.5

1.0

-5 -4 -3 -2 -1 0 1 2 3 4 5

Tasa CP dólares Tasa CP soles

Correlaciones entre las tasas de interés en t+i y PBI en t

(2002.1:2005.3)

-1.0

-0.5

0.0

0.5

1.0

-5 -4 -3 -2 -1 0 1 2 3 4 5

Tasa CP dólares Tasa CP soles

Ahora: Countercylical Policy: Y interest rates

Before IT: Procyclical monetary policy

Conclusion A great contribution. It generates debate

in the literature of economic growth

Very careful estimations. But a deeply theoretical understanding of the link between fiscal policy volatility and growth is needed.