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.
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).
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.
This chapter concludes the analysis in this book with an agenda for moving the region forward, drawing on the discussions of preceding chapters and the accompanying empirical analyses. While a survey of current policies through the Caribbean suggests that there is plenty of work yet to do on the fiscal sustainability agenda, the lack of an economic recovery in the presence of high debt for many countries calls for action. While each country will need to tailor its specific strategy, we outline below some key elements that should be part of any medium-term framework that countries in the region may consider adopting. Already, some countries are responding to the need for action by independently selecting some elements of the menu proposed in this book and putting them in place to meet their debt reduction targets. These include some difficult and complex new institutional arrangements, such as Jamaica’s proposals for implementing a new fiscal rule.
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?
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.