A. Debt and Deficits

Stock-flow residuals are often measured as the difference between changes in gross debt and deficits. This measure is incomplete (although a good second best for large N empirical analysis, given data limitations). Figure 1 shows the relationship between surplus or deficit and changes in gross debt for a sample of 35 countries. The information covers the general government (central, state,⁵ and local) over the 1995–2012 period and the measure is ‘net lending/borrowing’ as defined in GFSM 2014. Where observations do not fall on the imposed line, changes in gross debt and deficits differ and stock flow residuals will be non-zero. The observations in Figure 1 suggest that general governments can run surpluses while increasing gross debt and run a deficit while paying off gross debt The average change in debt for the sample is 4.0 percent GDP (sd=6.5) and average deficit is 1.8 percent GDP (sd=4.8).

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General Government Fiscal Balances and Changes in Gross Debt

(Percent of GDP)

Citation: IMF Working Papers 2015, 009; 10.5089/9781498353953.001.A001

Source: IMF GFSY (1995–14)

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The downside to this partial measure is expressed in the prevalence of observations falling off the imposed line across all quadrants in Figure 1. The opening quote of this section—the residual itself has too many meanings to be meaningful. To decompose this residual into more meaningful parts we examine the components of fiscal stocks and flows. As in Seiferling (2013), the complete stock-flow adjustment is an accounting identity which recognizes the roles of financial assets and other economic flows (volume and valuation changes). Consistent with international standards (GFSM 2014), the relationship between partial and complete stock-flow residuals can be characterized in four accounting identities:

(i) government change in net financial worth:⁶

(ii) government change in gross debt:

(iii) government surplus/deficit:⁷

(iv) other economic flows (volume and valuation changes):

Financial assets and liabilities are classified into eight separate instruments (debt securities, loans, other accounts payable, currency and deposits, SDRs, and insurance, pension and standardized guarantee schemes), and:

ΔD_t is the first differenced stock of gross government debt in period t.⁸

δ_t is net lending/borrowing (deficit/surplus) in period t.

${\tilde{x}}_i^q$ represents transactions in instrument i during fiscal year t(q=FA for financial assets) or (q=L for liabilities)

$\Delta va{l}_{x_{i,t}^q}$ represents holding gains and/or losses or re-evaluations of an asset (q=NFA, FA) or liability (q=L) for instrument i in period i; and

$\Delta vo{l}_{x_{i,t}^q}$ represents changes in the volume of an asset (q=FA) or liability (q=L) for instrument i in period t that do not result from a transaction or from valuation change.

From equations (1b) and (1c), the first conventional measure of stock-flow residuals reduces to:

and the difference between changes in net financial worth and fiscal flows reduces to zero:

From equations (2a) and (2b), there are two missing components which should resolve discrepancies between changes in gross debt and fiscal deficits: transactions in financial assets $\left({\displaystyle {\sum }_{i=1}^8{\tilde{x}}_{it}^{FA}}\right)$ and other economic flows $\left({\displaystyle {\sum }_{i=1}^6(\Delta va{l}_{x_{it}^L}+\Delta vo{l}_{x_{it}^L})}\right)$.⁹ Figure 2 shows the relationship between fiscal flows ((1c) + (1d)) and changes in government net financial worth (1a) for the same sample of countries/years in Figure 1.

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General Government Flows^* and Changes in Net Financial Worth^**

(Percent of GDP)

Citation: IMF Working Papers 2015, 009; 10.5089/9781498353953.001.A001

Source: IMF GFSY (1995–2014)Notes: ^* see equations (1c) and (1d)^** see equation (1a)

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B. Transactions in Financial Assets

While the liability side of a government’s balance sheet receives more attention in analytical or policy work, governments also hold portfolios of financial assets. These can have important implications for debt sustainability (a large stock of highly liquid financial assets can offset unexpected increases in short term gross debt) and governments overall net worth. Incorporating information on government transactions in financial assets and other economic flows dramatically improves our ability to understand fiscal performance and to generate more meaningful analytical results. This can be illustrated by comparing Figure 1 with Figure 2 below. The extent of realignment between observations in the two figures suggests that the magnitude of these two ‘missing links’ is not trivial. It is encouraging that not all observations fall exactly on the imposed line—there are a variety of reasons for stocks and flows to marginally differ (timing differences, rounding, statistical discrepancies, etc.).

Table 1 reports data on the net acquisition of financial assets for three averaged or discrete time periods: pre-2008, 2008 and post-2008. The range of these averages shows large variances across instruments and over time.

Table 1.

Pre- and Post-Crisis Net Transactions in Financial Assets by Instrument ^1/

(Percent of GDP)

Source: IMF GFSY (1995–2014)

^1/Excludes Monetary gold and SDRs and ‘Insurance, Pension and Standardized Guarantee Schemes (GFSM 2014).

^2/Average

Table 1.

Pre- and Post-Crisis Net Transactions in Financial Assets by Instrument ^1/

(Percent of GDP)

Transaction - Financial Assets	Pre-2008 2/	2008	Post-2008 2/
Net Acquisition of Financial Assets	0.9 (2.3)	4.0 (6.4)	1.6 (3.1)
Currency and Deposits	0.3 (1.5)	1.0 (3.2)	0.1 (2.1)
Debt Securities	0.3 (1.3)	0.4 (0.7)	0.23 (1.5)
Loans	0.02 (0.8)	1.3 (3.5)	0.2 (1.0)
Equity and Investment Fund Shares	−0.01 (1.4)	0.9 (2.0)	0.6 (1.6)
Other Accounts Receivable	0.4 (0.7)	0.4 (0.7)	0.4 (0.8)
Financial Derivatives and Employee Stock Options	−0.02 (0.1)	−0.001 (0.06)	−0.02 (0.1)

Source: IMF GFSY (1995–2014)

^1/Excludes Monetary gold and SDRs and ‘Insurance, Pension and Standardized Guarantee Schemes (GFSM 2014).

^2/Average

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Table 1.

Pre- and Post-Crisis Net Transactions in Financial Assets by Instrument ^1/

(Percent of GDP)

Transaction - Financial Assets	Pre-2008 2/	2008	Post-2008 2/
Net Acquisition of Financial Assets	0.9 (2.3)	4.0 (6.4)	1.6 (3.1)
Currency and Deposits	0.3 (1.5)	1.0 (3.2)	0.1 (2.1)
Debt Securities	0.3 (1.3)	0.4 (0.7)	0.23 (1.5)
Loans	0.02 (0.8)	1.3 (3.5)	0.2 (1.0)
Equity and Investment Fund Shares	−0.01 (1.4)	0.9 (2.0)	0.6 (1.6)
Other Accounts Receivable	0.4 (0.7)	0.4 (0.7)	0.4 (0.8)
Financial Derivatives and Employee Stock Options	−0.02 (0.1)	−0.001 (0.06)	−0.02 (0.1)

Source: IMF GFSY (1995–2014)

^1/Excludes Monetary gold and SDRs and ‘Insurance, Pension and Standardized Guarantee Schemes (GFSM 2014).

^2/Average

Decomposing government acquisition of financial assets adds several new dimensions of information.¹⁰ A closer look at the dynamics of the three highlighted categories shown in Figure 3 below suggests that investment in shares and equities tend to be most variable in terms of magnitude for both advanced and emerging countries.

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Average Transactions in Selected Financial Assets

(Advanced and Emerging Economies)

Citation: IMF Working Papers 2015, 009; 10.5089/9781498353953.001.A001

Source: IMF GFSY (1995–2012)

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A notable difference between the two groups of countries shown in Figure 3 is the high degree of reliance in developing and emerging economies on currency and deposits, with more dispersed portfolios in advanced economies where shares and equities feature more prominently (especially during bailouts in 2008). Governments in advanced economies tend to place greater emphasis on extending loans and purchasing equity in temporarily insolvent firms during financial crisis than emerging market governments.

C. Other Economic Flows (Volume and Valuation Changes)

Other economic flows are broadly characterized as changes in the value of an asset or liability which are not the outcome of transactions. This broad categorization can be decomposed into two categories: holding gains/losses ($\Delta va{l}_{x_{it}^L}$—valuation changes) and volume changes $\left(\Delta vo{l}_{x_{it}^L}\right)$ (see equation (1d)). Holding gains/losses represent changes in the monetary value of an asset or liability resulting from changes in market prices including those resulting from changes in exchange rates (GFSM 2014). This is a reflection of the current market value of the asset or liability relative to its previous market value, or on the asset side, the unrealized profits/losses or changes in exchange rates on the current stock and portfolio of financial investments. Along with interest and dividend revenue (realized returns on financial investments), holding gains provides very useful information on the performance of a government’s current stock of financial investments.

Volume changes represent a range of events which are neither transactions nor holding gains. Some examples of volume changes would be a decrease in net worth due to natural disasters, the reclassification of government units of the general government, unilateral debt write-offs, or the discovery of government assets/liabilities for which there is no past information (see GFSM 2014). These are relatively rare events but have the potential to significantly impact a government’s balance sheet. Figure 4 shows density plots for volume changes where the expected value is centered around zero with very skinny tails ranging from -2 to 2 percent of GDP.

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General Government Financial Asset Volume Change Densities

Citation: IMF Working Papers 2015, 009; 10.5089/9781498353953.001.A001

Source: IMF GFSY (1995–2012)

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Because other economic flows are not transaction based, many analytical approaches assume them to be outside of the realm of government performance as they are not within the direct control of policymakers. In some cases (volume changes due to natural disaster) this is certainly true, but in the case of holding gains or losses (valuation changes), these could, in normal economic times, be considered second order determinants of government performance as the investments themselves are determined, or at least controlled, by government.¹¹ Other economic flows for equity investments tend to be most variable in terms of magnitude for both advanced and emerging countries (Table 2). They are examined more closely in Section IV.

Table 2.

Pre- and Post-Crisis Other Economic Flows in Financial Assets by Instrument

(Percent of GDP)^1/

Source: IMF GFSY (1995–2014)

^1/Excludes Monetary gold, SDRs, and “Insurance, Pension and Standardized Guarantee Schemes” (GFSM 2014).

^2/Average

Table 2.

Pre- and Post-Crisis Other Economic Flows in Financial Assets by Instrument

(Percent of GDP)^1/

Other Economic Flows	Pre-2008 2/	2008	Post-2008 2/
Net Acquisition of Financial Assets	1.26 (3.75)	−1.94 (5.61)	1.16 (2.81)
Currency and Deposits	0.04 (0.40)	0.09 (0.36)	−0.004 (0.20)
Debt Securities	−0.03 (0.42)	0.49 (2.59)	−0.24 (1.19)
Loans	−0.03 (0.40)	0.60 (1.94)	−0.03 (0.28)
Equity and Investment Fund Shares	1.30 (3.57)	−2.86 (6.96)	1.30 (2.44)
Other Accounts Receivable	−0.06 (0.38)	−0.26 (0.70)	0.07 (0.33)
Financial Derivatives and Employee Stock Options	0.05 (0.29)	−0.04 (0.26)	0.06 (0.27)

Source: IMF GFSY (1995–2014)

^1/Excludes Monetary gold, SDRs, and “Insurance, Pension and Standardized Guarantee Schemes” (GFSM 2014).

^2/Average

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Table 2.

Pre- and Post-Crisis Other Economic Flows in Financial Assets by Instrument

(Percent of GDP)^1/

Other Economic Flows	Pre-2008 2/	2008	Post-2008 2/
Net Acquisition of Financial Assets	1.26 (3.75)	−1.94 (5.61)	1.16 (2.81)
Currency and Deposits	0.04 (0.40)	0.09 (0.36)	−0.004 (0.20)
Debt Securities	−0.03 (0.42)	0.49 (2.59)	−0.24 (1.19)
Loans	−0.03 (0.40)	0.60 (1.94)	−0.03 (0.28)
Equity and Investment Fund Shares	1.30 (3.57)	−2.86 (6.96)	1.30 (2.44)
Other Accounts Receivable	−0.06 (0.38)	−0.26 (0.70)	0.07 (0.33)
Financial Derivatives and Employee Stock Options	0.05 (0.29)	−0.04 (0.26)	0.06 (0.27)

Source: IMF GFSY (1995–2014)

^1/Excludes Monetary gold, SDRs, and “Insurance, Pension and Standardized Guarantee Schemes” (GFSM 2014).

^2/Average

The size and variability of these two missing links in the stock-flow residual suggests that they can play an important role in the determination of a country’s overall fiscal health and transparency. The acquisition of financial assets (i) is important for liquidity purposes to offset liabilities with short term maturities, especially in the case of emerging/developing economies; (ii) can provide a source of significant profits for surplus generating governments; and (iii) serve as an important mechanism by which governments can minimize/absorb some of the damage from exogenous shocks to other sectors of the economy. Other economic flows provides additional data on the valuation changes of these investments from secondary markets and changes in foreign exchange rates. Together, these components complete the stock-flow identity and allow for a more comprehensive analysis of the relationship between stock-flow residuals and fiscal transparency.

A. Model Specification

Our focus is on the value of general government transactions in, and returns on, equities. We specify the following two equations:

and

where:

κ_jt is general government j’s transactions in financial asset q over time period t and t+1

${\tau }_{qjt}^p$ is the marginal realized (p = R) and unrealized (p = U) returns on the stock of equities at time t in country j

${\tau }_{jt}^M$ captures volatility and magnitude of private market returns (year on year changes in the S&P 500 index)

nlb_jt is general government j’s net lending borrowing (surplus/deficit) in year t as a percent of GDP

chdebt_jt is general government j’s change in gross debt between year t and year t-1 as a percent of GDP

crisis_jt measures the binary existence of a banking crisis in country j at time t

Δfx_jt measure changes in exchange rates (relative to the US dollar in country j over time t

trnsp_j measures fiscal transparency in country j using IMF ROSC database (see Weber 2012)

X_jt is a matrix containing information on exogenous macroeconomic conditions in country j at time t (GDP, growth, banking crisis, exchange rates)

(λ, α^U, α^R, δ, η, θ, ρ, α_M, π, β) are unknown parameter to be estimated.

The logic of this specification is relatively straightforward: (i) acquisition/sale of equities can be a good investment for surplus generating countries (δ > 0), (ii) debt is an alternative option for deficit generating countries for financing acquisition of equities (η > 0) which, (iii) can be used to soften the impact of exogenous shocks on other sectors in the case of a banking crisis (ρ > 0) or act as a countercyclical reaction to general downturn in private markets (α^U < 0).

With respect to unrealized returns on government equity portfolios, we choose a relatively parsimonious specification (given data constraints) which models government equity returns as a function of changes in private market equity returns, fiscal transparency, and movements in foreign exchange rates (for foreign held assets).

We estimate (3a) and (3b) using a random intercept model where ε_Ejt = ζ_j + ϵ_jt and ν_Ejt = ϑ_j + ω_jt where [ζ_j, ϑ_j] are time constant (permanent) error terms which vary across countries and [ϵ_jt, ω_jt] are transitory across time and countries. The consistency of parameter estimates from this GLS estimated specification, relative to a fixed effects approach, is validated using a Hausman-test.¹⁵

B. Results

Results for (3b) and for an unbalanced panel of 19 countries, respectively, are shown below with bootstrapped standard errors in parenthesis. As expected, unrealized returns on government equities are significantly correlated with private market returns on equities. From the sample of 19 countries in column 1 of Table 3, government equity portfolios should expect 0.2 percent higher returns given a 1 percent increase in the S&P 500 index. From this, general governments appear to be potentially more risk averse than private markets with their equity portfolios. There also appears to be a somewhat robust relationship between fiscal transparency and unrealized returns on government equity portfolios (see Figure 6).

Table 3.

General Government: Unrealized Returns on Shares and Equity

Source: Authors’ calculations Note: *** - significant at p<0.01; ** - significant at p<0.05; * - significant at p<0.1

Table 3.

General Government: Unrealized Returns on Shares and Equity

	Domestic and Foreign		Domestic
Dependant variable:	General	General	General	General
αU	Government	Government net of Social Security	Government	Government net of Social Security
(unrealized returns)
τM	0.20***	0.16**	0.12***	0.12***
(market returns)	(0.07)	(0.64)	(0.03)	(0.03)
γ	6.63*	9.73*	9.76	6.72
(fiscal transparency)	(3.63)	(5.85)	(6.73)	(10.42)
Π	0.008	0.007
(annual changes in FX %)	(0.13)	(0.07)
λ	−0.002	−0.01	−0.001	0.09
(lagged unrealized returns)	(0.10)	(0.06)	(0.16)	(0.19)
Constant	−1.87	−3.41	−2.79	−1.30
	(2.86)	(4.17)	(4.79)	(7.26)
Countries	19	14	10	9
Observations	240	160	94	84
Rsq (within)	0.09	0.06	0.04	0.04
Rsq (between)	0.57	0.39	0.42	0.42
Rsq (overall)	0.10	0.09	0.08	0.07

Source: Authors’ calculations Note: *** - significant at p<0.01; ** - significant at p<0.05; * - significant at p<0.1

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Table 3.

General Government: Unrealized Returns on Shares and Equity

	Domestic and Foreign		Domestic
Dependant variable:	General	General	General	General
αU	Government	Government net of Social Security	Government	Government net of Social Security
(unrealized returns)
τM	0.20***	0.16**	0.12***	0.12***
(market returns)	(0.07)	(0.64)	(0.03)	(0.03)
γ	6.63*	9.73*	9.76	6.72
(fiscal transparency)	(3.63)	(5.85)	(6.73)	(10.42)
Π	0.008	0.007
(annual changes in FX %)	(0.13)	(0.07)
λ	−0.002	−0.01	−0.001	0.09
(lagged unrealized returns)	(0.10)	(0.06)	(0.16)	(0.19)
Constant	−1.87	−3.41	−2.79	−1.30
	(2.86)	(4.17)	(4.79)	(7.26)
Countries	19	14	10	9
Observations	240	160	94	84
Rsq (within)	0.09	0.06	0.04	0.04
Rsq (between)	0.57	0.39	0.42	0.42
Rsq (overall)	0.10	0.09	0.08	0.07

Source: Authors’ calculations Note: *** - significant at p<0.01; ** - significant at p<0.05; * - significant at p<0.1

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Predicted Unrealized Returns on Government Equity Portfolios and Fiscal Transparency

Citation: IMF Working Papers 2015, 009; 10.5089/9781498353953.001.A001

Source: Authors’ calculations

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These results suggest that relatively transparent governments tend to hold significantly more profitable equity portfolios by a magnitude of between 6 to 8 percent relative to less transparent governments. This relationship is especially pronounced in the case of government returns on domestic equities (dashed line). With respect to transactions in equities, results for (3a) and for an unbalanced panel of 25 countries are shown respectively below with bootstrapped standard errors in parenthesis (Table 4). As expected, the key drivers of government net acquisitions of equities are fiscal balances (surplus generating countries are more likely to acquire equities), changes in gross debt, and exogenous shocks to other sectors (banking crisis). Realized returns (dividend receipts) appear to play a minimal role in governments’ acquisition of equities with the consistently negative coefficient on unrealized returns potentially signifying a government’s willingness to invest in equities during market downturns.

Table 4.

Government Net Acquisition of Shares and Equity

Source: Authors’ calculations Note: *** - significant at p<0.01; ** - significant at p<0.05; * - significant at p<0.1

Table 4.

Government Net Acquisition of Shares and Equity

	Domestic and Foreign		Domestic
Dependant variable: κEjt (net acquisition of equities)	General Government	General Government net of Social Security	General Government	General Government net of Social Security
δSE (net lending/borrowing)	0.27*** (0.08)	0.14*** (0.05)	0.12* (0.07)	0.14** (0.07)
ηE (changes in gross debt)	0.13*** (0.03)	0.13*** (0.04)	0.08** (0.04)	0.10*** (0.03)
ρSE (banking crisis)	0.57* (.32)	0.52** (0.26)	0.90* (0.53)	0.56* (0.32)
αRSE (realized returns)	−0.07 (0.05)	−0.06 (0.04)	−0.05 (0.07)	−0.01 (0.05)
αUSE (unrealized returns)	−0.04* (0.03)	−0.3** (0.13)	−0.03* (0.02)	−0.02 (0.02)
Constant	1.92 (1.86)	0.09 (1.99)	−0.73 (2.42)	−1.36 (2.06)
Countries	25	18	18	15
Observations	274	200	180	148
Rsq (within)	0.21	0.37	0.21	0.20
Rsq (between)	0.70	0.30	0.19	0.44
Rsq (overall)	0.41	0.36	0.21	0.23

Source: Authors’ calculations Note: *** - significant at p<0.01; ** - significant at p<0.05; * - significant at p<0.1

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Table 4.

Government Net Acquisition of Shares and Equity

	Domestic and Foreign		Domestic
Dependant variable: κEjt (net acquisition of equities)	General Government	General Government net of Social Security	General Government	General Government net of Social Security
δSE (net lending/borrowing)	0.27*** (0.08)	0.14*** (0.05)	0.12* (0.07)	0.14** (0.07)
ηE (changes in gross debt)	0.13*** (0.03)	0.13*** (0.04)	0.08** (0.04)	0.10*** (0.03)
ρSE (banking crisis)	0.57* (.32)	0.52** (0.26)	0.90* (0.53)	0.56* (0.32)
αRSE (realized returns)	−0.07 (0.05)	−0.06 (0.04)	−0.05 (0.07)	−0.01 (0.05)
αUSE (unrealized returns)	−0.04* (0.03)	−0.3** (0.13)	−0.03* (0.02)	−0.02 (0.02)
Constant	1.92 (1.86)	0.09 (1.99)	−0.73 (2.42)	−1.36 (2.06)
Countries	25	18	18	15
Observations	274	200	180	148
Rsq (within)	0.21	0.37	0.21	0.20
Rsq (between)	0.70	0.30	0.19	0.44
Rsq (overall)	0.41	0.36	0.21	0.23

Source: Authors’ calculations Note: *** - significant at p<0.01; ** - significant at p<0.05; * - significant at p<0.1

Because κ = f_κ(τ) and τ = f_τ(τ^M, trnsp), we assume that the effects of fiscal transparency and market volatility on government net acquisitions of equities can be isolated by imputing predictions from (3b) into (3a) holding these constant one at a time.¹⁶ We use estimates of what market returns would look like if (i) holding fiscal transparency constant and varying market returns $f_{\tau }({\tau }_{jt}^M,\overline{trnsp})$ and (ii) holding market volatility constant while varying fiscal transparency $f_{\tau }(\overline{{\tau }_{jt}^M},trnsp)$. Plugging these estimates for f_τ into f_κ via τ_SE captures the second order effect of fiscal transparency on government acquisition of equities in the first case $\left(\overline{trnsp}\right)$, and captures the second order effects of private market volatility in the second case $\left(\overline{{\tau }_{jt}^M}\right)$.

The predicted first order effects of a banking crisis and second order effects of private market fluctuations in equity prices on net acquisitions of general government equities from equation (3b) are shown in Figure 7. The dashed and solid lines show the predicted net acquisition of government equities during banking crisis and in normal times, respectively. Moving along the x-axis, we can see that governments tend to partially favor equities during market downturns, which could work as a countercyclical mechanism to restore short-term confidence in the market. Moving along the y-axis, it appears that governments tend to be highly active in providing equity injections during domestic banking crisis. This effect is especially pronounced for investments in domestic equities where governments appear to be more sensitive to banking crisis, providing a ‘cushion’ during periods of exogenous shocks to other sectors of the economy.

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Government Acquisitions of Equities—Market Downturns and Bank Crises

Citation: IMF Working Papers 2015, 009; 10.5089/9781498353953.001.A001

Source: Authors’ calculations

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The predicted second order effect of fiscal transparency on governments’ net acquisitions of equities is shown in Figure 8. While an interesting avenue for future research would be the second order multiplicative effects of fiscal transparency and market returns on net acquisition of equities (are less transparent governments more likely to sell off financial assets during crisis), equation (3b) characterizes these as being additive and thus independent.¹⁷

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Government Acquisitions of Equities and Fiscal Transparency

Citation: IMF Working Papers 2015, 009; 10.5089/9781498353953.001.A001

Source: Authors’ calculations

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This independence allows for a separation of the effects of market volatility and fiscal transparency. The second order relationship in Figure 8 is independent of changes in the equities market. During normal times, we would, therefore, expect less transparent governments to acquire relatively larger equity portfolios than more transparent ones (moving along the x-axis), which is generally consistent with past findings (Buti et al., 2007; Alt et al., 2014).¹⁸ Combining this with the findings from Figure 6, less transparent countries should be expected to generate significantly lower average returns on larger portfolios suggesting the potential that these portfolios contain some degree of ‘policy lending’ or ‘unsafe assets.’