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Code and data files for "Fiscal Policy and Default Risk in Emerging Markets"
TL;DR: In this article, all Matlab and C++ programs necessary to produce the results of the article were described and a spreadsheet with Mexican data was also provided, along with a spreadsheet containing Mexican data.
Abstract: All Matlab and C++ programs necessary to produce the results of the article. There is also a Excel spreadsheet with Mexican data.
Citations
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TL;DR: In this paper, a general equilibrium model of both sovereign default and business cycles is proposed, which explains several features of cyclical dynamics around deraults, countercyclical spreads, high debt ratios and key business cycle moments.
Abstract: Emerging markets business cycle models treat default risk as part of an exogenous interest rate on working capital, while sovereign default models treat income fluctuations as an exogenous endowment process with ad-noc default costs. We propose instead a general equilibrium model of both sovereign default and business cycles. In the model, some imported inputs require working capital financing; default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around default triggers an efficiency loss as these inputs are replaced by imperfect substitutes; and default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around deraults, countercyclical spreads, high debt ratios, and key business cycle moments. This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.
464 citations
TL;DR: In this article, the authors build a dataset on tax rates for 62 countries for the period 1960-2013 that comprises corporate income, personal income, and value-added tax rates and find that tax policy is a cyclical in industrial countries but mostly procyclical in developing countries.
Abstract: It is well known by now that government spending has typically been procyclical in developing economies but a cyclical or countercyclical in industrial countries. Little, if any, is known, however, about the cyclical behavior of tax rates (as opposed to tax revenues, which are endogenous to the business cycle and hence cannot shed light on the cyclicality of tax policy). The authors build a novel dataset on tax rates for 62 countries for the period 1960-2013 that comprises corporate income, personal income, and value-added tax rates. The authors find that, by and large, tax policy is a cyclical in industrial countries but mostly procyclical in developing countries. Further, tax policy in countries with better institutions and or more integrated with world capital markets tends to be less procyclical or more countercyclical.
142 citations
TL;DR: In this article, the authors extend the model used in recent quantitative studies of sovereign default, allowing policymakers of different types to stochastically alternate in power, and show that a default episode may be triggered by a change in the type of policymaker in office, and that such a default is likely to occur only if there is enough political stability and if policymakers encounter poor economic conditions.
Abstract: We extend the model used in recent quantitative studies of sovereign default, allowing policymakers of different types to stochastically alternate in power. We show that a default episode may be triggered by a change in the type of policymaker in office, and that such a default is likely to occur only if there is enough political stability and if policymakers encounter poor economic conditions. Under high political stability, political turnover enables the model to generate a weaker correlation between economic conditions and default decisions, a higher and more volatile spread, and lower borrowing levels after a default episode.
132 citations
TL;DR: In this article, the authors identify critical flaws in the traditional approach to evaluate debt sustainability, and examine three alternative approaches that provide useful econometric and model-simulation tools to analyze debt sustainability.
Abstract: The question of what is a sustainable public debt is paramount in the macroeconomic analysis of fiscal policy. This question is usually formulated as asking whether the outstanding public debt and its projected path are consistent with those of the government's revenues and expenditures (ie, whether fiscal solvency conditions hold). We identify critical flaws in the traditional approach to evaluate debt sustainability, and examine three alternative approaches that provide useful econometric and model-simulation tools to analyze debt sustainability. The first approach is Bohn's nonstructural empirical framework based on a fiscal reaction function that characterizes the dynamics of sustainable debt and primary balances. The second is a structural approach based on a calibrated dynamic general equilibrium framework with a fully specified fiscal sector, which we use to quantify the positive and normative effects of fiscal policies aimed at restoring fiscal solvency in response to changes in debt. The third approach deviates from the others in assuming that governments cannot commit to repay their domestic debt and can thus optimally decide to default even if debt is sustainable in terms of fiscal solvency. We use these three approaches to analyze debt sustainability in the United States and Europe after the sharp increases in public debt following the 2008 crisis, and find that all three raise serious questions about the prospects of fiscal adjustment and its consequences.
110 citations
TL;DR: In this paper, the authors study the sovereign default model that has been used to account for the cyclical behavior of interest rates in emerging market economies and show that this method necessitates a large number of grid points to avoid generating spurious interestrate movements.
Abstract: We study the sovereign default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interestrate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space technique is more severe for parameterizations that feature a high sensitivity of the bond price to the borrowing level for the borrowing levels that are observed more frequently in the simulations. In addition, we find that the efficiency of the discrete state space technique can be greatly improved by (i) finding the equilibrium as the limit of the equilibrium of the finite-horizon version of the model, instead of iterating separately on the value and bond price functions and (ii) concentrating grid points in asset levels at which the bond price is more sensitive to the borrowing level and in levels that are observed more often in the model simulations. Our analysis is also relevant for the study of other credit markets.
105 citations
References
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TL;DR: In this article, the authors introduce limited commitment into a standard optimal fiscal policy model in small open economies, and define a small open emerging economy as an economy where the limited commitment problem is active in equilibrium.
18 citations
TL;DR: In this article, the authors investigated and empirically tested the link between climate change and sovereign risk in Southeast Asia and found that greater climate vulnerability appears to have a sizable positive effect on sovereign bond yields, while greater resilience to climate change has an offsetting effect, albeit to a lesser extent.
Abstract: This article investigates and empirically tests the link between climate change and sovereign risk in Southeast Asia. Southeast Asian countries are among those most heavily affected by climate change. The number and intensity of extreme weather events in the region have been increasing markedly, causing severe social and economic damage. Southeast Asian economies are also exposed to gradual effects of global warming as well as transition risks stemming from policies aimed at mitigating climate change. To empirically examine the effect of climate change on the sovereign risk of Southeast Asian countries, we employ indices for vulnerability and resilience to climate change and estimate country-specific OLS models for six countries and a fixed effects panel using monthly data for the period 2002–2018. Both the country-specific and the panel results show that greater climate vulnerability appears to have a sizable positive effect on sovereign bond yields, while greater resilience to climate change has an offsetting effect, albeit to a lesser extent. A higher cost of debt holds back much-needed investment in public infrastructure and climate adaptation, increases the risk of debt sustainability problems, and diminishes the development prospects of Southeast Asian countries.
18 citations
01 Jan 2015
TL;DR: A comprehensive survey of the literature on emerging economies can be found in this article under the following sub-headings: (1) Underdeveloped institutions, (2) Unclear and inconsistent policies, (3) Inadequate governance, (4) Disjointed infrastructure, (5) Limited funding options (6) Inhibiting culture, (7) Personalized networks, (8) Ill-funded and ambivalent education system, and (9) Reluctant internationalization.
Abstract: Though ‘emerging economies’ is one of the widest used terms in discussions on global economies, it takes different meanings in different contexts to suit the main issue under discussion. An operational definition that could serve as a general description of this group it that they are low income, rapid growth countries using economic liberalization as their primary engine of growth under severe constraints of institutional deficiencies. The size and character of this group kept changing to accommodate the needs of the issue under discussion. Currently there are two main sub-groups within the conglomerate group of Emerging Economies (EE), namely: the developing countries in Asia, Latin America, Africa and the Middle East and the transition economies in the former Soviet Union and China. While it is often predicted by ‘economy-watchers’ that EE will be a major economic power in about 30 to 50 years, their growth and development are constrained by institutional deficiencies, which are summarized in this paper (based on a comprehensive survey of the literature) under the following sub-headings: (1) Underdeveloped institutions, (2) Unclear and inconsistent policies, (3) Inadequate governance, (4) Disjointed infrastructure (5) Limited funding options (6) Inhibiting culture, (7) Personalized networks, (8) Ill-funded and ambivalent education system, and (9) Reluctant internationalization. The overall impact of these inadequacies is that entrepreneurs have to overcome several constraints for setting up and growing their ventures. Hence much of their innovativeness would be exercised on devising the means to overcome these constraints rather than in designing, developing and marketing innovative products and services. Thus they tend to develop a style of muddling through towards venture creation and growth.
18 citations
TL;DR: In this paper, a Markov-switching vector autoregressive model is applied to data from the Republic of Argentina to assess the timing and thresholds of the dynamic system, and results show the significance of political factors in explaining sovereign risk for Argentina.
17 citations
TL;DR: The authors found that government expenditures are procyclical in emerging markets and counter-cyclical by contrast to developed economies, and that social transfer policies can account for about half of the larger cyclical volatility of consumption relative to output in emerging economies compared to developed.
17 citations