Appendix I. The Reduction of Expenditures in Present Value Terms
Appendix II. Optimal Structural Surplus
Appendix III. The Model
Appendix IV. Calibration of the Model
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We thank C. Caceres, J. Galí, M. Kumar, C. Vegh, J. de Gregorio, S. Elekdag, J.P. Medina, J. Roldos, and discussants at the University of Chile, Central Bank of Chile, Catholic University of Chile, and the IMF Institute. William Baeza coded several simulations. Remaining errors are the authors’ own. Restrepo conducted much of the work at the Central Bank of Chile.
Examples include the European Community (the 1991 Maastricht treaty) and several less industrialized countries (including the fiscal responsibility laws enacted Brazil and Peru). More recently, Turkey has considered a fiscal rule as a way to build market confidence.
Some have suggested that governments overspend and/or delay fiscal adjustment because public resources have no one specific owner. This ‘common pool’ problem gives rise to another one of time inconsistency (Kydland and Prescott, 1977) since i) authorities try to obtain political dividends in the short run (Alesina and Tabellini, 1990), and ii) each area of government tries to spend as much as possible on its preferred projects. Also, coalitions that favor fiscal reform frequently fray at the edges since some members seek to avoid the political costs of its implementation (Velasco, 1994).
Talvi, and Végh (2005) suggest that governments face pressures to spend money at the moment when they receive it. Gavin and Perotti (1997) suggest that governments cut spending during downturns when they are excluded from global credit markets—as often happens during a crisis.
Woodford points out that the optimization must be ‘timeless’—the authority cannot change the parameters of the objective function, and each period’s optimization takes place as if it were the initial period.
Under the Ramsey approach (see for example Végh, 2008) policy makers maximize the primal utility functions of market participants themselves, rather than some dual objective function which may be ad-hoc in nature. For a detailed critique of the Ramsey approach, see Kocherlakota (2010). However, most would agree ad hoc fiscal rules may be easy to understand and implement—and they may benefit consumers.
Our model, like other real business cycle models, assumes a steady state around which key variables move, including a net debt or credit position. So they are bounded. From a policyperspective, boundless asset accumulation by the government poses several problems. For example, the government might at some point own large portions of (and have excessive influence over) the economy; this point is noted in IMF (2009).
Originally, Chile’s structural surplus—one percent of GDP—was justified by the need to pay off debt incurred by the central bank after the 1982 financial crisis. However, the consolidated debt of the public sector—non-financial plus central bank—fell during the 2000s. More recently, that target was reduced, first to ½ of one percent of GDP, then more recently to zero, thus reducing asset accumulation. On public asset accumulation, see Aiyagari, Marcet, Sargent, and Seppalla (2002).
While the notation used in this section is meant to be a simplification of that used in the general equilibrium simulation in Part IV, it will not exactly conform.
An equation like (1) may also be expressed in terms of total output; in this case, the interest factor must be adjusted for GDP growth. However, our analysis would apply only to the dynamically efficient case wherein the rate of interest exceeds the rate of output growth.
Only rarely would a budget be exactly balanced. Small unexpected discrepancies might be financed through withdrawals from existing government bank deposits.
Several authors, including Kimball (1990), Weil (1993), Caballero (1990), Carroll and Kimball (2008), and Carroll (2009) note that a third moment (—prudence”) in the utility function will give rise to a precautionary motive. Hugget and Ospina (2001) note that a third moment is not required generating precautionary savings in the aggregate. However, we refer to individual consumer behavior in this paper.
As Kim and Kim (2003) note, log-linearized business-cycle models are inappropriate for welfare analysis since they are unable to account for the effect of the variance of the shocks on economic decisions. Thus, we compute the welfare gains generated by moving from one rule to the other, finding the change in steady-state consumption (£) required to make any household indifferent (in expected utility terms) between the procyclical balanced budget and the acyclical spending rule.
Mendoza and Oviedo (2004) find that in emerging economies under uncertainty, the —a version to a collapse in outlays leads the government to respect a “natural debt limit” equal to the annuity value of the primary balance in a fiscal crisis.”
We assume for simplicity that there are no private copper exports; we treat them as if they were transfers from abroad.
The steady state values are consistent with those obtained for the Chilean Economy where foreign debt is around 50 percent of GDP. See for example Restrepo and Soto (2006).
We assume that each period corresponds to one quarter.
See Agénor and Montiel (1996), Table 10.1, page 353.
For our chosen utility function, there is no closed form solution linking consumption and volatility.