The global financial crisis has led to renewed interest in the issue of debt reduction for many governments. Low economic growth, low budgetary revenues, and stimulus spending to prop up economic activity have resulted in a sizable accumulation of debt, especially by the developed world. For instance, the ratio of general government debt to GDP increased from 50 percent in 2007 to 90 percent during the crisis in advanced economies. In the Caribbean, the ratio of public debt to GDP increased by about 15 percentage points between 2008 and 2010.
A number of governments across the world have adopted fiscal policy rules, especially against the backdrop of worsening fiscal performances and rising debt levels. Recently, following the financial crisis, fiscal rules have been advocated to support fiscal consolidation efforts and to ensure long-term sustainability of government finances. This chapter empirically analyzes the impacts of fiscal rules on fiscal performance in microstates with a focus on the Caribbean, where fiscal consolidation has been a major challenge. Broadly, we address three questions. Are there fiscal rules in microstates in general, and in the Caribbean in particular? If the answer is yes, what types of rules exist and what are their characteristics? Is the existence of fiscal rules in microstates associated with improved fiscal performance?
Caribbean economies face high and rising debt-to-GDP ratios that jeopardize prospects for medium-term debt sustainability and growth. This book provides a comprehensive analysis of the challenges of fiscal consolidation and debt reduction in the Caribbean. It examines the problem of high debt in the region and discusses policy options for improving debt sustainability, including fiscal consolidation, robust growth, and structural reforms. The book also examines empirically the factors underlying global large debt reduction episodes to draw important policy lessons for the Caribbean. It also reviews the literature on successful fiscal consolidation experiences and provides an overview of past and current consolidation efforts in the Caribbean. The book concludes that the region needs a broad and sustained package of reforms to reduce debt ratios to more manageable levels and strengthen economic resilience.
Mr. Yehenew Endegnanew, Charles Amo-Yartey, and Ms. Therese Turner-Jones
This chapter examines the empirical link between fiscal policy and the current account focusing on microstates, defined as countries with a population of less than 2 million between 1970 and 2009. The extent to which fiscal adjustment can lead to predictable development in the current account remains controversial, with two competing views. The traditional view argues that changes in fiscal policy are associated with changes in the current account through a number of channels that are discussed in the literature review. The traditional view is challenged by the Ricardian equivalence principle, which states that an increase in budget deficit (through reduced taxes) will be offset by increases in private saving, insofar as the private sector fully discounts the future tax liabilities associated with financing the fiscal deficit, hence not affecting the current balance.
Joel Chiedu Okwuokei, Charles Amo-Yartey, and Mr. Machiko Narita
Countries in the Caribbean have undertaken fiscal consolidation at various times with the primary objective of putting the debt-to-GDP ratio on a sustainable downward trajectory. Yet public debt levels in most of these countries remain high today, suggesting that past and ongoing fiscal consolidation efforts have not yielded durable benefits. Some questions immediately come to mind. Why are public debts levels not falling as one would expect? Would it be connected with the Caribbean approach to fiscal consolidation, country-specific circumstances, or some challenges unique to the region? What are the characteristics of fiscal consolidation in the region, and how different are they from the experiences around the world?
The Caribbean has a track record of high fiscal deficits, partly reflecting procyclical fiscal policies in good times. This has resulted in elevated levels of public-debt-to-GDP ratios since 1990. The predominant source of the budget imbalance is the central governments, even though public enterprises have also contributed significantly to the debt buildup. The debt accumulation stems from countercyclical fiscal policy in bad times and procyclical fiscal policy during periods of economic boom. The net result is that debt which has accumulated during periods of weak growth is not offset in good times, resulting in higher levels of debt in the medium term (Egert, 2011).
Governments facing high debt levels and seeking to undertake fiscal consolidation are often confronted with a number of interrelated questions. What promotes a successful fiscal consolidation? How large should the adjustment be and how fast? Should one adjust now or later, and what are the consequences of postponing adjustment? Should one cut expenditures, raise revenues or do both? Which components of expenditures or revenues should one adjust, and does the composition of adjustment really matter? Would the adjustment be self-defeating? Is there a political price for fiscal adjustment?
Caribbean economies face high and rising debt-to-GDP ratios that jeopardize prospects for medium-term debt sustainability and growth. In 2011, the region’s overall public sector debt was estimated at about 70 percent of regional GDP (Figure 1.1). Interest payments on the existing debt stock in the most highly indebted countries with rising debt ratios are already in the range of 16 percent to 42 percent of total revenues. In addition, high amortization exposes some countries to considerable roll-over risk that could trigger a fiscal crisis.
The recent global financial crisis has drawn renewed attention to the effectiveness of fiscal policy, as many countries implemented fiscal stimulus measures to boost economic activity. The effectiveness of fiscal policy is often assessed by the size of fiscal multipliers, which measure a change in output caused by an exogenous change in government spending or tax revenue. This chapter estimates fiscal multipliers for the Caribbean using quarterly data for 14 Caribbean countries,1 and investigates key determinants of the size of the multipliers. The results show that fiscal multipliers in the sample countries are modest, and that the high levels of trade openness and public debt account for their modest size.