Fiscal consolidation talk at unicef

FISCAL CONSOLIDATION & INEQUALITY

Prakash Loungani Advisor, Research Department, IMF

Co-Chair, IMF “Jobs and Growth” Working GroupSeptember 2013

VIEWS EXPRESSED SHOULD NOT BE ATTRIBUTED TO THE IMF OR TO MY CO-AUTHORS.

Background presentation for talks at UNICEF (September 9) and World Bank (September 12). I thank Hites Ahir, Ezgi Ozturk and Jair Rodriguez for excellent research assistance.

Outline 1. Evolution of fiscal policy over the Great Recession

– Coordinated fiscal stimulus at onset of crisis– Then, turn to consolidation

2. IMF advice on fiscal policy

– Support for initial fiscal stimulus– On consolidation: credible medium-term plans rather than strong

front-loading– Fiscal policy and output: WEO chapter (Will it Hurt?)– Fiscal multipliers: Blanchard-Leigh– Fiscal policy and global recoveries: Kose, Loungani, Terrones

3. Fiscal consolidation and inequality

Fiscal Policy during the Great Recession

• Coordinated global fiscal stimulus at the onset of the crisis

• Over 2007-09, a significant increase in public debt, in large part because of the collapse in tax revenues

• Against this backdrop, many governments started to undertake or plan policies to reduce government debt and deficits, through a combination of spending and tax-based consolidation measures

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Revenue losses were the bulk of projected increase in public debt

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Estimate of "fiscal space": Red, yellow and green cells indicate probability less than 50 percent, between 50 and 85 percent, and above 85 percent, respectively.

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IMF Supported Initial Fiscal Stimulus

“The optimal fiscal package should be timely, large, lasting, diversified, contingent, collective, and sustainable:

timely, because the need for action is immediate;

large, because the current and expected decrease in private demand is exceptionally large;

Lasting, because the downturn will last for some time;

diversified because of the unusual degree of uncertainty associated with any single measure;

contingent, because the need to reduce the perceived probability of another “Great Depression” requires a commitment to do more, if needed;

collective, since each country that has fiscal space should contribute; and

sustainable, so as not to lead to a debt explosion and adverse reactions of financial markets. “

Fiscal Policy for the Crisis, Dec. 29, 2008Antonio Spilimbergo, Steve Symansky, Olivier Blanchard,and Carlo Cottarelli

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IMF Advice on Fiscal Consolidation

• It is important to have realistic expectations about the consequences of fiscal consolidation

• Consolidations are contractionary (WEO Chapter, “Will it Hurt?”)

• Previous global recoveries relied on expansionary fiscal policies (Kose, Loungani, Terrones, 2013)

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IMF Advice on Fiscal Consolidation

• Fiscal consolidation should be gradual, with credible medium-term plans

• Effects of fiscal consolidation on growth should be offset by other measures to the extent possible

- Continued ease in monetary policies- Financial sector repair & reform

• Fiscal measures that are approved now but only kick in to reduce deficits in the future—when the recovery is more robust—would be particularly helpful. Examples include linking statutory retirement ages to life expectancy and improving the efficiency of entitlement program

• Fiscal consolidation plans should spell out how policies would respond to shocks, such as slower growth than envisaged in the plan

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Fiscal Policy and Global Recoveries:Why is this recovery slow?

• Many theories– recovery from financial crises are typically slower

– deleveraging provides headwinds to the recovery

– policy uncertainty

• Stance of policies

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A Recovery on Track? World Real GDP per capita

Notes: Dashed lines denote WEO forecasts. Indexed to 100 in the year before global recession. Zero is the time of the global recession year. Each line show the PPP-weighted average of the countries in the sample.

Figure 1. Real GDP Per Capita

(index, PPP weighted)

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Global Recession Year

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Recovery from the Great Recession

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The Divergence in Recoverybetween Advanced Countries and Emerging Markets

Figure 2. Real GDP per Capita: Advanced Countries and Emerging Markets

Notes: Dashed lines denote WEO forecasts. Indexed to 100 in the year before global recession. Zero is the time of the global recession year. Each line show the PPP-weighted average of the countries in the respective group.


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Divergence in Government Spending between this Global Recovery and Past Global Recoveries

Notes: Dashed lines denote WEO forecasts. Indexed to 100 in the year before global recession. Zero is the time of the global recession year. Each line show the PPP-weighted average of the countries in the respective group.

Figure 3. Real Primary Expenditure


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Divergence in Government Spending between this Global Recovery and Past Global Recoveries:

US and Euro Area

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How IMF was viewed on fiscal issues during our 2013 Spring Meetings

How the IMF became the friend who wants us to work less and drink more

-- Washington Post April 16, 2013

“It is to the credit of the economists at the Fund that their recommendations to policymakers have adapted to this strange world we’re living in rather than sticking with their more normal, doctrinaire advocacy of monetary and fiscal restraint.”

IMF Renews Push Against Austerity

-- Wall Street JournalApril 17, 2013

“ … the International Monetary Fund called on countries that can afford it -- including the U.S. and Britain -- to slow the pace of their austerity measures.”

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IMF Statement on Fiscal Policy in Spain

“I strongly support the Spanish government's objectives of restoring a sound fiscal position while securing a recovery and creating jobs. Today's announcement to pursue a more gradual consolidation path is a welcome step toward meeting these goals, building on major reforms and structural fiscal improvements last year.”

– Christine Lagarde, April 26, 2013IMF

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The distributional effects of fiscal consolidation

(joint work with Larry Ball and Daniel Leigh)

Why should we care about inequality?

Potential economic and social costs

Lower duration of growth spells (Berg & Ostry, 2011)

Latent social conflicts (Campante and Chor, 2012)

Greater use of leverage induces financial crises (Fitoussi and Saraceno, 2010; Kumhof and Ranciere, 2010)

Lower intergenerational mobility and increased health problems (Wilkinson and Pickett, 2010)

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Data

• Gini for disposable income (Standardized World Income Inequality Database -- SWIID; Solt 2009 & 2011)

• Shares of wage and profit in GDP (OECD Analytical Database);

• Short (lasting less than six months) and long-term (lasting more than six months) unemployment rates taken from the OECD Analytical Database.

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Data

•Fiscal consolidation episodes are taken from Devries et al. (2011) database.

•The database contains information on 173 episodes of fiscal consolidation for 17 OECD economies (Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Netherlands, Portugal, Spain, Sweden, the United Kingdom, and the United States) during 1978-2009.

•Measures of fiscal consolidation based on a narrative approach and focuses on policy actions.

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Cumulative changes in Gini before and after fiscal consolidation episodes

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Cumulative changes in the wage share before and after fiscal consolidation episodes

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Regression framework

Impulse Response Functions by Local Projections (Jorda, 2005)

G = measure of inequality

D =dummy variable that takes the value equal to 1 for the starting date of a consolidation episode in country i at time t and 0 otherwise

=distributional impact of fiscal consolidation episodes for each future period k

IRF obtained by estimating the equation for each k and plotting the beta coefficients

𝐺𝑖,𝑡+𝑘 −𝐺𝑖,𝑡 = 𝛼𝑖𝑘 +𝑇𝑖𝑚𝑒𝑡𝑘 + 𝛾𝑗𝑘𝑙𝑗=1 ∆𝐺𝑖,𝑡−𝑗 +𝛽𝑘𝐷𝑖,𝑡 +𝜀𝑖,𝑡𝑘

𝛽𝑘

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The effect of fiscal consolidation on inequality (Gini)

Note: dotted lines equal one standard error bands.

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The effect of fiscal consolidation on inequality (Gini)Fi

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MEDIUM-TERM EFFECT OF CONSOLIDATIONS ON GINI SWIID OECD SWIID for

observations in the OECD database

Milanovic’s All the Ginis

database 𝐺𝑖𝑛𝑖𝑖,𝑡+5 −𝐺𝑖𝑛𝑖𝑖,𝑡 0.456 (2.04)**

1.294 (3.43)***

0.836 (3.20)***

2.223 (2.02)**

N 473 55 55 147 R2 0.13 0.27 0.17 0.12 Note. T-statics based on clustered robust standard errors in parenthesis. **, **** denote significance at 5% and 1%, respectively

The effect of fiscal consolidation on inequality (Gini)- spending vs. tax-based adjustments

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The effect of fiscal consolidation on wage income (% of GDP)

Note: dotted lines one standard error bands.

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The effect of fiscal consolidation on wage vs. profits and rents (percentage change)

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The effect of fiscal consolidation on wage income spending vs. tax-based (percentage change)

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The effect of fiscal consolidation on short vs. long-term unemployment

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Key Results

• Fiscal consolidation episodes have typically had significant distributional effects:

• increase inequality by 0.1 percentage point (about 0.4 percent) in the very short term, and by 0.9 percentage point (about 3.4 percent) over the medium term;

•significant and long-lasting fall in the wage income share of about 0.8 percentage point of GDP;

• raise long-term unemployment by about 0.5 percent over the medium term.

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Fiscal consolidation occurring via spending restraints

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Conclusions

“While growth is essential for the future global economy, it must be a different kind of growth, inclusive and not simply the fallout of unfettered globalization. The policy implications of such a reorientation are profound … It requires a fiscal policy that focuses not only on efficiency, but also on equity, particularly on fairness in sharing the burden of adjustment, and on protecting the weak and vulnerable.”

Christine Lagarde (China Daily, Dec. 27, 2012)

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Business

Fiscal consolidation talk at unicef