Summaries

Expansionary fiscal policies in the United States in the early 1980s and contemporaneous fiscal restraint in the Federal Republic of Germany and Japan constituted important shifts in fiscal positions among industrial economies. The international economy was simultaneously characterized by persistently high real interest rates, a rising U.S. current account deficit, increased surpluses in Germany and Japan, and sustained appreciation of the U.S. dollar’s real exchange rate. More recently, passage in late 1985 of the Gramm-Rudman-Hollings measures to reduce the U.S. federal fiscal deficit was associated with significant declines in both interest rates and the dollar.

Abstract

Expansionary fiscal policies in the United States in the early 1980s and contemporaneous fiscal restraint in the Federal Republic of Germany and Japan constituted important shifts in fiscal positions among industrial economies. The international economy was simultaneously characterized by persistently high real interest rates, a rising U.S. current account deficit, increased surpluses in Germany and Japan, and sustained appreciation of the U.S. dollar’s real exchange rate. More recently, passage in late 1985 of the Gramm-Rudman-Hollings measures to reduce the U.S. federal fiscal deficit was associated with significant declines in both interest rates and the dollar.

International Transmission of Fiscal Policies in Major Industrial Countries—paul r, masson and malcolm knight (pages 387–438)

Expansionary fiscal policies in the United States in the early 1980s and contemporaneous fiscal restraint in the Federal Republic of Germany and Japan constituted important shifts in fiscal positions among industrial economies. The international economy was simultaneously characterized by persistently high real interest rates, a rising U.S. current account deficit, increased surpluses in Germany and Japan, and sustained appreciation of the U.S. dollar’s real exchange rate. More recently, passage in late 1985 of the Gramm-Rudman-Hollings measures to reduce the U.S. federal fiscal deficit was associated with significant declines in both interest rates and the dollar.

This paper examines how the effects of fiscal policies are transmitted internationally. Our analysis emphasizes that fiscal shifts of recent years constitute major disturbances to saving and investment flows. An increase in a country’s fiscal deficit corresponds to a higher level of public sector dissaving. Unless this change is completely offset by an increase in private sector saving relative to domestic investment, the larger fiscal deficit will lead to an increased inflow of foreign saving, placing upward pressure on world interest rates. For increased foreign saving to enter through the capital account, the current account deficit must rise via an appreciating real exchange rate. An autonomous rise in investment, such as that induced by U.S. tax measures passed in 1981–82, produces qualitatively similar effects in the short run.

We specify and estimate a model of saving, investment, and net exports for the United States. Germany, and Japan using data for the period 1961-83. Simulations suggest that a permanent fiscal deficit reduction of 1 percent of capacity output in any one of the three largest industrial countries produces a significant decline in real interest rates and a large initial depreciation in that country’s currency. U.S. tax incentives for investment would induce higher interest rates and an appreciated dollar. Simulations of the combined effects of increased U.S. investment and observed movements in inflation-adjusted deficits in all three countries in 1981-85 suggest that substantial fractions of these interest and exchange rate movements were related to shifts in fiscal policy.

The Consequences of Real Exchange Rate Rules for Inflation: Some Illustrative Examples—charles adams, and daniel gros (pages 439–76)

In the past few years, several countries have implemented rules that seek to adjust the nominal exchange rate in such a way as to prevent losses of competitiveness. Although the manner in which these rules have been implemented has varied among countries, exchange rate adjustments have typically been made on the basis of the difference between inflation at home and abroad, frequently with a lag reflecting delays in receiving price information.

This paper argues that these rules—real exchange rate rules—are likely to lead to a loss of control over the inflationary process in the sense of making it difficult for the authorities to achieve a targeted path for inflation. The reason for this result is straightforward: following real exchange rate rules may serve ultimately to index both the nominal exchange rate and, through the balance of payments, the money supply to the price level. Under these conditions, there may be no exogenous nominal anchor to tie prices down; in situations in which inflation starts to rise (or fall), there may be no effective mechanism for controlling it except in the very short run. Any attempt to control inflation (or disinflation) could lead to a loss of control over some other economic variable, such as foreign assets or the current account balance, which could result in an unsustainable external position over the longer term.

The result that a real exchange rate rule could lead to a loss of control over the inflationary process follows from the general principle that a sound monetary or exchange rate policy is needed to provide an anchor for prices in the long run; under a real exchange rule, ceilings for the growth of domestic credit or of the money supply are not, in general, adequate anchors. Because there is more disagreement about the determinants of prices in the short run than in the long run, however, the paper uses several different examples of the short-run behavior of economies to illustrate the loss of control over inflation implied by following real exchange rate rules.

Selective Credit Controls in Greece: A Test of Their Effectiveness—lazaros e. molho (pages 477–508)

How effective are policies that attempt to stimulate fixed investment by selectively increasing the supply of long-term credit and by reducing its cost? Analysis of the question is motivated here by the Greek experience during the mid-1970s. Although the Greek authorities exercised tight control over credit allocation and interest rates during that period, there is evidence that the optimizing behavior of both lenders and borrowers tended to weaken the effectiveness of selective credit policies.

This paper draws some of the policy implications of this optimizing behavior by developing a model of the firm’s investment and financing decisions. Credit policies are analyzed separately for the cases of excess demand for and excess supply of loans. In the typical case of excess demand for loans, the model implies that a policy of increasing the relative supply of long-term loans will be most effective in stimulating fixed investment when the firm views this policy as temporary. If it perceives the policy to be permanent, the firm will change its pattern of financing of fixed and working capital, thereby neutralizing the stimulus for fixed investment.

The model’s predictions are corroborated by investment equation estimates for a cross section of Greek industrial firms over the period 1973-77. The firms’ investment function appears to have shifted between 1973-74. when the authorities attempted to restrict short-term credit selectively, and 1976-77, when this policy was abandoned. Firms tended to offset the relative contraction of short-term credit during 1973-74 by diverting a greater share of long-term and internal funds to finance working capital, while using a smaller share of these funds to finance fixed capital. From the viewpoint of econometric practice, the implied endogeneity of financing patterns suggests that appropriate stability tests should constitute an integral part of any empirical assessment of the effectiveness of selective credit controls.

Labor Market Disequilibrium and the Scope for Work-Sharing: A Case Study of the Netherlands—klaus-walter riechel (pages 509–40)

Many governments have responded to the sharp rise in unemployment and its persistence during the past decade by promoting work-sharing schemes that are expected to combine higher employment with shorter working hours. This paper assesses the preconditions and scope for work-sharing by examining disequilibrium in the Dutch labor market.

An analysis shows that most indicators of workers’ labor supply functions point to a strong “income preference” and to the related dominance of the “added worker” over the “discouraged worker” effect. (The discouraged worker no longer looks for a job.) Wage restraint in the past years and official labor market policies have contributed to these preferences. Wage restraint in particular appears to have encouraged spouses and other family members to work, with the result that women have joined the work force at an exceptionally high rate, although participation rates have also stopped falling for men. Moreover, official labor market policies appear to have raised the chances for formerly inactive people to find a job and have thereby reduced the usual discouragement caused by high unemployment. Taken together, these factors suggest that under current economic conditions the introduction of work-sharing schemes, especially combined with an uncompensated (in terms of incomes) reduction of working hours, may increase participation in the labor supply. Higher participation in the labor force will, however, raise rather than lower the unemployment rate if there are not enough jobs available.

On the labor demand side, the long-standing preference of employers seems to be to raise average working hours relative to employment, a development that runs counter to work-sharing. To examine firms’ employment preferences in general and the causes for this phenomenon in particular, the paper develops a small model to estimate the effect on labor demand of the desired split of labor inputs between employment and working hours. The results of this estimation suggest that strong impediments to a successful introduction of work-sharing in the Netherlands still exist. Of particular importance are fixed nonwage labor costs and a number of rigidities that raise fixed nonwage and other labor costs and thereby impede a flexible and low-cost adjustment of the labor force to fluctuations in activity. Moreover, the characteristics of unemployment point to a loss in overall productivity and a corresponding increase in unit labor costs in the case of a legislated substitution of employment for average working hours. To be successful, work-sharing schemes need to be combined with measures that reduce fixed employment costs and other rigidities. Work-sharing schemes also have to adapt flexibly to the particular needs of individual industries and firms.

Macroeconomic Policy Design in an Interdependent World Economy: An Analysis of Three Contingencies—willem h. buiter (pages 541–82)

The paper uses a small analytical two-region model (the Mundell-Dornbusch model, as first adapted by Marcus Miller), consisting of the United States and the rest of the industrial world, to analyze three issues concerning international economic interdependence and macroeconomic policy coordination.

First, what should be the monetary or fiscal response in the rest of the industrial world to a tightening of U.S. fiscal policy, and what should be the U.S. monetary response? A unilateral U.S. fiscal contraction would cause a temporary slowdown of world economic activity and a sudden drop in the nominal and real value of the dollar. A compensating fiscal expansion in the rest of the industrial world would make the U.S. economy more competitive without a global slump but would be inconsistent with a reduction in the global real interest rate. A move toward accommodating monetary policy in both regions, however, could improve U.S. competitiveness and reduce the world real interest rate while maintaining full employment.

Second, what should be the monetary or fiscal response in the United States and in the rest of the industrial world to a collapse of the U.S. dollar? If a sudden drop in the dollar reflects the bursting of a speculative bubble, there are no obvious monetary and fiscal policy implications. Collapses reflecting perceived changes in fundamentals do, however, in general call for stabilization policies. A shift in liquidity preference out of the dollar calls for open market sales in the United States and open market purchases in the rest of the industrial world.

Third, what should be the macroeconomic policy response both in the United States and in the rest of the industrial world to a disappointing performance of real growth? If a slowdown in global economic activity reflects an adverse supply shock, a reduction in demand is needed in both regions to avoid stagflationary consequences. If deficient private effective demand is the culprit, appropriate expansionary fiscal or monetary responses are called for.

The final section of the paper discusses and qualifies the activist policy conclusions derived from the formal analysis. It concludes that any credibility problems that arise (such as the reversibility of expansionary “temporary fiscal stimuli” or the ability to commit the monetary authority not to attempt to use inflationary surprises to stimulate output or to amortize non-index-linked government debt in real terms) are potentially serious but have political and institutional solutions.

An Optimizing Model of Household Behavior Under Credit Rationing—peter montiel (pages 583–615)

The transmission mechanism through which monetary policy affects real output and the price level depends on the structural and institutional characteristics of individual economies. For many developing countries, relevant characteristics probably include deficient access by the private sector to foreign sources of finance and rationing of bank credit at below-market interest rates. The link between changes in flows of credit to the private sector and changes in aggregate demand in such a setting is not adequately understood. The standard presumption in this case is that an increase in the availability of credit to the private sector will have a strong effect on aggregate demand through increased private investment.

This presumption is examined in the paper in the context of an intertemporal optimization model of household behavior. An important outcome of the model is that, although private capital accumulation is affected by credit availability in the short run, changes in the availability of credit leave the private sector’s capital stock unchanged in the long run. Furthermore, credit availability also affects household consumption and money demand in both the short run and the long run, raising the possibility that additional credit will finance increased consumption and hoarding. Finally, under credit rationing, increases in deposit interest rates may increase consumption in both the short run and the long run.

The model producing these results relies on assumptions—such as a fixed rate of time preference and costless and instantaneous portfolio adjustment—-that, although widely used, are somewhat restrictive and should be relaxed. Relaxing them may affect the dynamic behavior and long-run constancy of the capital stock, but the effects on consumption and the demand for money analyzed here, as well as the consequences of changes in market interest rates, are likely to prove robust in the face of reasonable generalizations.

IMF Staff papers: Volume 33 No. 3
Author: International Monetary Fund. Research Dept.