Annex I. Fiscal Space: Selected Indicators
This annex provides additional background information on a range of potential indicators that could inform the analysis of fiscal space at the various stages considered in this note.
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Discretionary policy can take the form of either a fiscal expansion or a slower pace of consolidation. In principle, some countries may be judged to not have space even to allow automatic stabilizers to operate.
Thresholds are somewhat easier to define for emerging markets, where episodes of fiscal stress have been relatively more common. For advanced economies, the empirical literature extensively covers topics such as intertemporal fiscal solvency and fiscal multipliers, but relatively little attention is paid to whether they can reach constraints to public debt financing.
These are based on the framework discussed in Cottarelli (2011), and summarized in the April 2011 Fiscal Monitor.
Other relevant work by the Fund in this area includes the conceptual framework for assessing sovereign risks presented in Cottarelli (2011) and empirical work by Ostry et al. (2010) and Ghosh et al. (2013). In the latter, fiscal space is defined in relation to a debt limit above which debt grows without bound given the country’s historical primary balance performance, i.e. this conception of fiscal space is based solely on the trajectory of public debt, and abstracts entirely from liquidity/rollover risk.
See Blanchard and Leigh (2013), Correia et al. (2013), and Mertens et al. (2014), for discussions of why multipliers are likely to be higher when monetary policy rates are close to the effective lower bound.
Based on the growth forecast track record calculated in the MAC-DSA, which compares the median forecast error for the country to the distribution of median forecast errors from other market-access countries. See IMF (2013) for more details.
In the case of countries covered by the MAC DSA this could be based on the realism module, which includes comparisons with cross-country historical experience.
To facilitate cross-country comparability, among the scenarios considered, it would be useful to include a standardized one across countries. This could also include a coordinated expansionary fiscal stance, which can contribute to creating fiscal space in a severe deflationary spiral, as shown in Scenario Box 2 in the April 2016 World Economic Outlook and Chapter 1 of the April 2016 Fiscal Monitor.
For instance, a country with an external position that is weaker than implied by medium-term fundamentals and with fiscal policy gaps contributing to this imbalance, could find risk premia to be more sensitive.
The signaling approach was proposed in a seminal paper by Kaminsky et al. (1998). It entails using identifying critical thresholds of potential indicators of crisis events that signal such events with the lowest prediction error.
As in the Fiscal Monitor, net debt is used for Australia, Canada and Japan. For Japan, the net debt target is 80 percent, which corresponds to a gross debt of 200 percent.