Abstract
This Selected Issues paper for Peru shows that during the years of strong growth and high commodity prices, the Peruvian authorities have conducted a prudent fiscal policy, maintaining a broadly neutral fiscal stance. During 2004–08, while the revenue-to-GDP ratio increased 3.7 percentage points, the expenditure ratio rose only 0.9 percentage points. Expenditure control focused on current spending and coincided with increasing government investment aimed at enhancing public access to infrastructure and social services. Fiscal policy has also outperformed budgets approved by congress, owing to higher-than-anticipated revenue, as well as the need to limit inflation pressures.
I. Macroeconomic Stability and the Role of Fiscal Policy 1
1. During the recent years of strong growth and high commodity prices, the Peruvian authorities have conducted a prudent fiscal policy, maintaining a broadly neutral fiscal stance. During 2004–08, while the revenue-to-GDP ratio increased 3.7 percentage points, the expenditure ratio rose only 0.9 percentage points (Figure 1). Expenditure control focused on current spending, and coincided with increasing government investment aimed at enhancing public access to infrastructure and social services. Overall, during 2004–08, the estimated fiscal impulse, measured as a structural balance loosening, averaged -0.2 percent of GDP, i.e., a broadly neutral fiscal stance.2 Fiscal policy has also outperformed budgets approved by Congress, owing to higher-than-anticipated revenue, as well as the need to limit inflationary pressures. For instance,. in 2008, the balanced budget approved by Congress would have implied a procyclical fiscal impulse, as measured by the change in the estimated structural balance, of about 3 percent of GDP. However, in response to rising inflation, the authorities announced in April an operative target for the fiscal surplus of 2 percent of GDP, which is currently expected to be the outturn.
Government Revenue, Expenditure, and Fiscal Impulse, 2004–08
(Percent of GDP)
Citation: IMF Staff Country Reports 2009, 041; 10.5089/9781451831184.002.A001
Source: Peruvian authorities and IMF staff estimates.Government Revenue, Expenditure, and Fiscal Impulse, 2004–08
(Percent of GDP)
Citation: IMF Staff Country Reports 2009, 041; 10.5089/9781451831184.002.A001
Source: Peruvian authorities and IMF staff estimates.Government Revenue, Expenditure, and Fiscal Impulse, 2004–08
(Percent of GDP)
Citation: IMF Staff Country Reports 2009, 041; 10.5089/9781451831184.002.A001
Source: Peruvian authorities and IMF staff estimates.2. This chapter assesses the effectiveness of a neutral fiscal stance in minimizing the impact of shocks on the economy. In particular, the analysis assesses how macroeconomic stability compares under a neutral fiscal stance and alternative strategies, such as a balance-budget approach. The paper also considers how the stabilizing properties of a neutral stance can be affected by errors in estimating potential revenue levels. This question is particularly relevant in an economy experiencing structural change, with a large informal sector, and when international commodity prices fluctuate widely.
3. The analytical framework is provided by the Global Integrated Monetary and Fiscal Model (GIMF). The model used here is a 2-country version of GIMF (Peru and the rest of the world) that shares many features with general equilibrium models introduced in central banks around the world. A key addition has been a model for the commodities sector, with commodity output modeled as an endowment. Commodity prices fluctuate with shocks to foreign industrial demand for these goods. The resulting swings in commodity prices generate fluctuations in government revenues. The model’s fiscal transmission mechanism is based on multiple non-Ricardian features. The structural parameters regarding household preferences and firm technology are set following Kumhof and Laxton (2007), who calibrated GIMF for the case of Chile and the rest of the world.
4. Fiscal policy in the model includes a target for the fiscal surplus. To reduce volatility from the business cycle and commodity-price shocks, the fiscal surplus is allowed to change with deviations of tax and commodity revenues from their trend levels. For the purpose of this paper, the fiscal rule is expressed as:
where
5. The key results are the following:
In the context of persistently high commodity prices, Peru’s broadly neutral fiscal stance has contributed substantially to macroeconomic stability compared to a balanced-budget approach. Following a balanced budget approach, as in the case of the 2008 budget, or running a fiscal deficit, as implied by the 2007 budget, would have destabilized output and inflation, contributed to a real appreciation of the currency and potential Dutch disease” effects, and raised the burden on monetary policy in addressing inflation. To illustrate this point, Figure 2 reports the dynamics of GDP, inflation, interest rates, real exchange rates, and the current account following an increase in the foreign demand that raises the price of commodities by 50 percent. The shock raises domestic income, and results in an improvement in the external current account balance, leading to an increase in domestic demand. Monetary policy tightens in response to the higher associated inflation, inducing a real appreciation of the currency. A neutral fiscal stance implies that a larger proportion of the revenue increase is saved, and that smaller interest rate increases are required to stabilize inflation. The smaller interest rate increases also reduce the degree of currency appreciation, and imply less crowding out of private investment and exports in the noncommodity sector. By contrast, a balanced-budget approach implies a procyclical increase in spending that stimulates aggregate demand, and implies the need for more monetary tightening to address inflation.
The superiority of a neutral fiscal stance over a balanced-budget approach is robust to the inclusion of misperceptions regarding potential revenue levels. In particular, the analysis suggests that a neutral fiscal stance offers greater macroeconomic stability than a balanced-budget approach even in the presence of misperception shocks, unless the severity of misperceptions is implausibly high.
Going forward, institutional reform to ensure the continuation of this prudent performance in an environment of volatile commodity prices is warranted. In particular, the adoption of a structural-balance rule would formalize the broadly neutral stance followed in recent years, provide a medium-term anchor for fiscal policy, and strengthen the credibility of fiscal policy by ensuring a balanced budget over the economic cycle. To alleviate concerns on assessing the stage of the economic cycle, the authorities could consider establishing independent expert panels as in Chile (OECD, 2006).
Raw-Materials Demand Shock and Fiscal Policy Cyclicality
(Deviation from Steady State Baseline)
Citation: IMF Staff Country Reports 2009, 041; 10.5089/9781451831184.002.A001
Source: GIMF simulations. Note: d=0 corresponds to a balance-budget approach, while d=1 corresponds to a neutral stance/structural-balance approach. The lines become lighter as the policy approach moves from d=0 to d=1.Raw-Materials Demand Shock and Fiscal Policy Cyclicality
(Deviation from Steady State Baseline)
Citation: IMF Staff Country Reports 2009, 041; 10.5089/9781451831184.002.A001
Source: GIMF simulations. Note: d=0 corresponds to a balance-budget approach, while d=1 corresponds to a neutral stance/structural-balance approach. The lines become lighter as the policy approach moves from d=0 to d=1.Raw-Materials Demand Shock and Fiscal Policy Cyclicality
(Deviation from Steady State Baseline)
Citation: IMF Staff Country Reports 2009, 041; 10.5089/9781451831184.002.A001
Source: GIMF simulations. Note: d=0 corresponds to a balance-budget approach, while d=1 corresponds to a neutral stance/structural-balance approach. The lines become lighter as the policy approach moves from d=0 to d=1.References
Kumhof, Michael, and Douglas Laxton, 2007, “Chile’s Structural Fiscal Surplus Rule: A Model-based Evaluation,” Selected Issues, IMF Country Report No. ---.
Lema, Rubén, and Eduardo Moreno, 2008, “Metodología de Cálculo del Resultado Estructural,” Notas de Estudios del BCRP, No. 51, September 22, 2008.
Organization for Economic Co-operation and Development, 2006, “Budgeting in Chile,” OECD Journal on Budgeting, Volume 4 Issue 2.
Prepared by Daniel Leigh.
A neutral fiscal stance is defined as no change in the structural fiscal balance (Lema and Moreno, 2008).
The results regarding the short-run stabilizing properties fiscal policies are robust to alternative values for the steady-state fiscal balance ø*.
