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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.
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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 find that shocks to trend growth rather than transitory fluctuations around a stable trend are the primary source of fluctuations in emerging markets, and the key features of emerging market business cycles are then shown to be consistent with this underlying income process in an otherwise standard equilibrium model.
Abstract: Emerging market business cycles exhibit strongly countercyclical current accounts, consumption volatility that exceeds income volatility, and “sudden stops†in capital inflows. These features contrast with developed small open economies. Nevertheless, we show that a standard model characterizes both types of markets. Motivated by the frequent policy regime switches observed in emerging markets, our premise is that these economies are subject to substantial volatility in trend growth. Our methodology exploits the information in consumption and net exports to identify the persistence of productivity. We find that shocks to trend growth—rather than transitory fluctuations around a stable trend—are the primary source of fluctuations in emerging markets. The key features of emerging market business cycles are then shown to be consistent with this underlying income process in an otherwise standard equilibrium model.
1,133 citations
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TL;DR: In this article, the authors present the first systematic analysis of the determinants and impact of thesovereign credit ratings assigned by the two leading U.S.agencies, Moody's Investors Service and Standard and Poor's.
Abstract: n recent years, the demand for sovereign credit rat-ings—the risk assessments assigned by the creditrating agencies to the obligations of central govern-ments—has increased dramatically. More govern-ments with greater default risk and more companiesdomiciled in riskier host countries are borrowing in inter-national bond markets. Although foreign government offi-cials generally cooperate with the agencies, ratingassignments that are lower than anticipated often promptissuers to question the consistency and rationale of sover-eign ratings. How clear are the criteria underlying sover-eign ratings? Moreover, how much of an impact do ratingshave on borrowing costs for sovereigns?To explore these questions, we present the firstsystematic analysis of the determinants and impact of thesovereign credit ratings assigned by the two leading U.S.agencies, Moody’s Investors Service and Standard andPoor’s.
1,060 citations
"Code and data files for "Fiscal Pol..." refers background in this paper
...…and Perri (2005) and Uribe and Yue (2006), who document that the cost of foreign credit is higher in recessions than in expansions, and with Cantor and Packer (1996) who find that sovereign credit ratings, which are valuations on the probability that a borrower will pay back its debts,…...
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TL;DR: In this paper, the authors proposed a method for computing tax rates using national accounts and revenue statistics. And they used this method to construct time-series of tax rates for large industrial countries.
Abstract: This paper proposes a method for computing tax rates using national accounts and revenue statistics. Using this method we construct time-series of tax rates for large industrial countries. The method identifies the revenue raised by different taxes at the general government level and defines aggregate measures of the corresponding tax bases. This method yields estimates of effective tax rates on factor incomes and consumption consistent with the tax distortions faced by a representative agent in a general equilibrium framework. These tax rates compare favorably with existing estimates of marginal tax rates, and highlight important international differences in tax policy.
1,054 citations
01 Jan 1989
TL;DR: In this article, a real-business-cycle model of a small open economy is proposed to rationalize the observed pattern of postwar Canadian business fluctuations, which is consistent with the observed positive correlation between savings and investment, even though financial capital is perfectly mobile, and with countercyclical fluctuations in external trade.
Abstract: This paper analyzes a real-business-cycle model of a small open economy. The model is parameterized, calibrated, and simulated to explore its ability to rationalize the observed pattern of postwar Canadian business fluctuations. The results show that the model mimics many of the stylized facts using moderate adjustment costs and minimal variability and persistence in the technological disturbances. In particular, the model is consistent with the observed positive correlation between savings and investment, even though financial capital is perfectly mobile, and with countercyclical fluctuations in external trade. Copyright 1991 by American Economic Association.
1,002 citations
TL;DR: In this paper, the authors developed a discrete state space solution method for a class of nonlinear rational expectations models by using numerical quadrature rules to approximate the integral operators that arise in stochastic intertemporal models.
Abstract: The paper develops a discrete state space solution method for a class of nonlinear rational expectations models. The method works by using numerical quadrature rules to approximate the integral operators that arise in stochastic intertemporal models. The method is particularly useful for approximating asset pricing models and has potential applications in other problems as well. An empirical application uses the method to study the relationship between the risk premium and the conditional variability of the equity return under an ARCH endowment process. NONLINEAR DYNAMIC RATIONAL EXPECTATIONS MODELS rarely admit explicit solutions. Techniques like the method of undetermined coefficients or forward- looking expansions, which often work well for linear models, rarely provide explicit solutions for nonlinear models. The lack of explicit solutions compli- cates the tasks of analyzing the dynamic properties of such models and generat- ing simulated realizations for applied policy work and other purposes. This paper develops a discrete state-space approximation method for a specific class of nonlinear rational expectations models. The class of models is distinguished by two features: First, the solution functions for the endogenous variables are functions of at most a finite number of lags of an exogenous stationary state vector. Second, the expectational equations of the model take the form of integral equations, or more precisely, Fredholm equations of the second type. The key component of the method is a technique, based on numerical quadrature, for forming a discrete approximation to a general time series conditional density. More specifically, the technique provides a means for calibrating a Markov chain, with a discrete state space, whose probability distribution closely approximates the distribution of a given time series. The quality of the approximation can be expected to get better as the discrete state space is made sufficiently finer. The term "discrete" is used here in reference to the range space of the random variables and not to the time index; time is always discrete in our analysis. The discretization technique is primarily useful for taking a discrete approxi- mation to the conditional density of the strictly exogenous variables of a model. The specification of this conditional density could be based on a variety of 1Financial support under NSF Grants SES-8520244 and SES-8810357 is acknowledged. We thank the co-editor and referees of earlier drafts for many, many helpful comments that substantially improved the manuscript.
955 citations