Fiscal Constraints & the Economy

8/7/2019 Fiscal Constraints & the Economy

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4 Politically Incorrect Questions4 Politically Incorrect Questions

Rob Parenteau, CFARob Parenteau, CFA

acro ra egy geacro ra egy geLevy Economics InstituteLevy Economics Institute

April 14, 2011April 14, 2011

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at s t e rea government u get constra ntat s t e rea government u get constra nt

How do fiscal constraints restrict the ran e of ossibleHow do fiscal constraints restrict the ran e of ossibleoutcomes for other sector financial balances?outcomes for other sector financial balances?

Does financialization lead to lower cor orateDoes financialization lead to lower cor orate

reinvestment rates (and hence larger fiscal deficits)?reinvestment rates (and hence larger fiscal deficits)?

so elusive?so elusive?

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= T + D + M= T + D + M

T = Tax RevenuesT = Tax RevenuesD = v rnm n D n inD = v rnm n D n in

M = Money StockM = Money Stock

Solvency defined:Solvency defined:PV of future (TPV of future (T--G) = or > initial DG) = or > initial D

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axes + on urc ases

overnmenSector

omes c r va eSector

Expenditures

Tax payments and bond purchases require moneyTax payments and bond purchases require moneyHouseholds and firms cannot create moneyHouseholds and firms cannot create money

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r y rr y r


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an s create money w en t ey cre t a epos t accountan s create money w en t ey cre t a epos t accountas they make loans, buy securitiesas they make loans, buy securities

But this is not a net financial asset of the private sectorBut this is not a net financial asset of the private sector

Central bank debits Treasur account credits a bankCentral bank debits Treasur account credits a bankaccount when it buys goods, services from private sectoraccount when it buys goods, services from private sector

that can be used to buy government bonds, pay taxesthat can be used to buy government bonds, pay taxes

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create the money they collect as taxes, bond revenuescreate the money they collect as taxes, bond revenues


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ax o gat ons orce t e pr vate sector to se goo s,ax o gat ons orce t e pr vate sector to se goo s,services, assets to the government for moneyservices, assets to the government for money

A government with a sovereign currency can never runA government with a sovereign currency can never runout of money: it creates the money it collectsout of money: it creates the money it collects

Government constraint is not financial (unless selfGovernment constraint is not financial (unless selfimposed as with debt ceilings, etc.) but rather realimposed as with debt ceilings, etc.) but rather real

Fiscal balance needs to be set with regard to realFiscal balance needs to be set with regard to realcapacity constraints in labor, P&E, resourcescapacity constraints in labor, P&E, resources

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Rating agencies should be assessing inflation risk, notRating agencies should be assessing inflation risk, notdefault risk, for sovereign currency nationsdefault risk, for sovereign currency nations


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Fiscal Constraints on Other SectorFiscal Constraints on Other SectorFinancial BalancesFinancial Balances

ota Saving = Tota Investmentota Saving = Tota Investment

(or Total Income=Total Expenditures)(or Total Income=Total Expenditures)

,=,,=, -- Government FB = TGovernment FB = T GG

Foreign FB = MForeign FB = M X, (or inverse of Current Account Balance)X, (or inverse of Current Account Balance)==

DPSFB + GFB + FFB = 0 (as financial balances must net to zero)DPSFB + GFB + FFB = 0 (as financial balances must net to zero)

DPSFB + GFBDPSFB + GFB CUB = 0CUB = 0

Change in one sector financial balance implies changes to other twoChange in one sector financial balance implies changes to other two

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Domestic Domestic

xpen ures

PrivateSector

overnmenSector

PrivateSector

ore gnSector

Taxes Imports

ang ng e or one sec or w ave mp ca ons orang ng e or one sec or w ave mp ca ons orthe remaining sectors (range of possible outcomes)the remaining sectors (range of possible outcomes)

88

For DPS to net save, need a) fiscal deficit, or b) tradeFor DPS to net save, need a) fiscal deficit, or b) trade

surplus, or more generally, CUB > GFBsurplus, or more generally, CUB > GFB


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3 Sector Financial Balances Ma3 Sector Financial Balances MaDomestic Private Sector Financial Balance = Current Account BalanceDomestic Private Sector Financial Balance = Current Account Balance Fiscal BalanceFiscal BalanceFiscal Surplus

DPS Deficit DPS Deficit DPS Surplus

Current Account

Surplus

Current Account

Deficit

DPS Deficit

DPS Surplus

DPS SurplusDomestic Private SectorFinancial Balance = 0%

99

Fiscal Deficit


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Fiscal Surplus

DPS Deficit DPS Deficit DPS Surplus

Current Account

Surplus

Current Account

Deficit

DPS Deficit

DPS Surplus

DPS SurplusDomestic Private SectorFinancial Balance = 0%

1010

Fiscal Deficit


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Fiscal Surplus

Current Account

Surplus

Current Account

Deficit

Domestic Private Sector

Very little room to achievea Domestic Private Sector Surplus

Financial Balance = 0 Fiscal Deficit = -3% of GDP

1111

Fiscal Deficit


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Fiscal Deficit > Current Account Deficit =Fiscal Deficit > Current Account Deficit =Large Private Sector Financial SurplusLarge Private Sector Financial Surplus

C u r r e n t A c c o u n t B a la n c e a s a S h a r e o f GD PG o v e r n m e n t F i n a n c i a l B a l a n c e a s a S h a r e o f G D P

2 .5 2 .5

0 .0

- 2 . 5

0 .0

- 2 . 5

- 5 . 0- 7 . 5

- 5 . 0- 7 . 5

1 050505050

- 1 0 . 0

- 1 2 . 5

- 1 0 . 0

- 1 2 . 5

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S o u r c e : H a v e r A n a l y t i c s


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Househo ld F inanc ia l Ba lance as a Shar e o f GDP

8 8

6

4

6

4

20

20

-2

-4

-2

-4

1313

1 05050505050Source: Haver Analytics

-4 -4


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N o n f a r m N o n f i n a n c i a l B u s i n e s s F i n a n c i a l B a l a n c e a s a S h a r e o f G D P4 q tr Mo v in gA v e ra ge- q t r M o v i n g A v e r a g eN o n f a r m N o n f i n a n c i a l B u s i n e s s F i n a n c i a l B a l a n c e a s a S h a r e o f G D P

4 4

2 2

0

-2

0

-2

1 050505050505

2

-4

2

-4

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S o u r c e : H a v e r A n a l y t i c s


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,,

P r e t a x C o r p o r a t e P r o f i t s a s a S h a r e o f G D P

C a p i t a l E q u i p m e n t a n d S o f t wa r e a s a S h a r e o f G D P1 4 1 4

1 2 1 2

1 0

8

1 0

8

1 0505050

8

6

8

6

1515

Source: Haver Analytics


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US Capital Stock on a Diet:US Capital Stock on a Diet:Financial Incentive Constraint?Financial Incentive Constraint?N et S to c k: P r iva te S tr u c tu r es : Q ua nti ty I nd exe t S tock : P r i va te S t ruc tu res : Quan t i ty I ndex% C ha n g e - Y e a r t o Y e a r 2 0 0 5 =1 0 0

Ne t S toc k : P r i va te Equ ipmen t & S o f twa re : Quan t i ty I ndex% C ha n g e - Y e a r t o Y e a r 2 0 0 5 =1 0 01 6 1 6

1 2

8

1 2

8

4

0

4

0

-4

-8

-4

-8

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0 50505050505050505Sources: Bureau of Economic Analysis /Haver Analytics


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US Business Financial Balance and theUS Business Financial Balance and theUnemployment RateUnemployment Rate

U n e m p l o y m e n t R a t e1 2 - m o n t h M o v i n g A v e r a g e S A , %

D o m e s ti c B u s i n e s s F i n a n c i a l B a l a n c e4 - q t r M o v i n g A v e r a g e

1 2 4

1 0 2

8

6

0

- 2

4

2

- 4

- 6

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1 050505050505S o u r c e : H a v e r A n a l y t i c s


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,,

Nonfarm Nonf inanc ia l Cor pora te Bus iness: Marke t Va lue o f E qu i t ies/Net W or th%

2 0 0 2 00

1 6 0 1 60

1 2 0

8 0

1 20

8 0

4 0

0

4 0

0

1818

1 050505050505Source: Federal Reserve Board /Haver Analytics

0 0


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ncent ve structures or managers an nvestors avencent ve structures or managers an nvestors ave

shifted over 30 years toward short term financial gainsshifted over 30 years toward short term financial gains

With exception of the New Economy Bubble,With exception of the New Economy Bubble,reinvestment of profits in US capital stock has been lowreinvestment of profits in US capital stock has been low

US job growth (and tax revenue growth) are dampenedUS job growth (and tax revenue growth) are dampenedif firms fail to reinvest profits in tangible capital stockif firms fail to reinvest profits in tangible capital stock

Changing incentive structures (and public/privateChanging incentive structures (and public/privateinvestment) may be required to revive secular growthinvestment) may be required to revive secular growth

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ax es an government expen ture cuts ra nax es an government expen ture cuts ra n

domestic private sector cash flowdomestic private sector cash flow

Growth then requires DPS to spend more out of itsGrowth then requires DPS to spend more out of itsincome flows (higher corporate reinvestment, for eg.)income flows (higher corporate reinvestment, for eg.)

Or requires trade balance to improveOr requires trade balance to improve

No automatic price adjustment (dollar, interest rate)No automatic price adjustment (dollar, interest rate)

2020


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Fiscal Consolidationor rediscoveringFiscal Consolidationor rediscoveringthe Paradox of Public Thrift?the Paradox of Public Thrift?

U . K . : P u b l i c S e c to r B u d g e t S u r p l us / D e f i c i t a s a % o f S A G D P ( S A , % )I r e la n d : C e n tr a l G o ve r n m e n t B u d g e t S u r p lu s / D e f i c i t a s a % o f S A G D P ( S A , % )S p a i n : C e n t ra l G o ve r n m e n t B u d g e t S u r p lu s / D e f i c i t a s a % o f S A / W D A G D P ( S A , % )

5 5

0

- 5

0

- 5

- 1 0

- 1 5

- 1 0

- 1 5

1 09876543210

- 2 0

- 2 5

- 2 0

- 2 5

2121

1 09876543210S o u r c e s : O N S , I C S O , S P B D E H / H a v e r


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U K Rea l GD P (Y oY % C hange )

I re land Rea l GDPSpa in Rea l GDP

2 0 2 0

1 5

1 0

1 5

1 05

0

5

0

-5

-1 0

-5

-1 0

2222

1 09876543210Sources: ONS, ICSO, SPENE /Haver

1 0 1 0


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E u r o A r e a 1 6 : T r a d e B a la n c e : T o ta lS A /WDA , M i l.E UR

1 2 0 0 0 1 2 0 0 0

8 0 0 0

4 0 0 0

8 0 0 0

4 0 0 00

- 4 0 0 00- 4 0 0 0

- 8 0 0 0

- 1 2 0 0 0

- 8 0 0 0

- 1 2 0 0 0

2323

1 09876543210S o u r c e : S t a t i s t i c a l O f f i c e o f t h e E u r o p e a n C o m m u n i t i e s / H a v e r A n al y t i c


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The true government budget constraint for nations with sovereignThe true government budget constraint for nations with sovereign,,

Constraining fiscal deficits will reduce the capacity for private sectorConstraining fiscal deficits will reduce the capacity for private sector,,

The business sector will be hesitant to reduce its net saving withoutThe business sector will be hesitant to reduce its net saving without

Expansionary fiscal consolidations require current account balancesExpansionary fiscal consolidations require current account balancesto im rove or the domestic rivate sector to reduce its net savinto im rove or the domestic rivate sector to reduce its net savin

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