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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, a dynamic political-economic model of total government obligations is presented, which focuses on the interplay between debt and entitlements and identifies preference polarization as a possible explanation for the joint growth of debt and entitlement.
Abstract: This article presents a dynamic political-economic model of total government obligations. Its focus is on the interplay between debt and entitlements. In our model, both are tools by which temporarily powerful groups can extract resources from groups that will be powerful in the future: debt transfers resources across periods; entitlements directly target the future allocation of resources. We prove the following results. First, the presence of endogenous entitlements dampens the incentives of politically powerful groups to accumulate debt, but it leads to an increase in total government obligations. Second, fiscal rules can have perverse effects: if entitlements are unconstrained, and there are capital market frictions, debt limits lead to an increase in total government obligations and to worse outcomes for all groups. Analogous results hold for entitlement limits. Third, our model sheds some lights on the influence of capital market frictions on the incentives of governments to adopt fiscal rules, and implement entitlement programs. Finally, we identify preference polarization as a possible explanation for the joint growth of debt and entitlements.
9 citations
01 Jan 2014
TL;DR: In this article, the authors collate and group Irish and UK Government strategies and policies adopted for the construction sector during the recession period 2007-2013; resulting in the establishment of a construction industry development framework and a taxonomic framework.
Abstract: Due to the high degree of international and economic integration across the globe, the 2007 global financial crisis quickly spread, causing recessions and widespread credit restrictions in advanced nations. During recessions, economic fluctuations cause dramatic changes to the market structure of industries, in particular, that of the construction sector. These structural changes can be further influenced by government strategies and policies; which if used incorrectly, can serve to fuel and exacerbate downturns. In contrasting form, during an economic recession, government strategies and policies can also be used to aid in exiting such economic turbulence. From an extensive review of literature it became apparent that very little research offered a comprehensive and systematic overview of Irish and UK construction related government policies and strategies adopted during recessions; hence the emergence of this topic. As part of an ongoing research PhD, the purpose of this paper is to collate and group Irish and UK Government strategies and policies adopted for the construction sector during the recession period 2007-2013; resulting in the establishment of a construction industry development framework and a taxonomic framework. The results reveal serious problems with the national strategic plan for the Irish construction industry, given that there is no overseeing body or target dates for implementation of the proposed actions. Furthermore, both countries failed to prioritize the proposed key actions within their strategic plans. The findings of this paper can be applied in the context of the construction sector to address shortcomings in the respective subsectors, while also aiding policy makers and company executives in mapping out future strategic milestones.
9 citations
Posted Content•
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 the inefficiency of the discrete state space technique is more severe for parameterizations such that the borrowing levels that are observed more frequently in the simulations feature a high sensitivity of the bond price to the borrowing level.
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 interest rate 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 such that the borrowing levels that are observed more frequently in the simulations feature a high sensitivity of the bond price to the borrowing level. 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. ; Replaces Working Paper 06-11 (Computing Business Cycles in Emerging Economy Models) ; Updated by Working Paper 10-04 (Quantitative Properties of Sovereign Default Models: Solution Methods Matter)
8 citations
TL;DR: In this paper, the authors explore the process of abandoning a fixed exchange rate regime during sudden stops in a small open economy, and build a model in which, in response to the country risk premium shock, the foreign-currency credit policy of a central bank under fixed regime leads to the exhaustion of international reserves and consequent exchange-rate regime shift.
Abstract: This paper explores the process of abandoning a fixed exchange rate regime during sudden stops in a small open economy The Bank of Korea’s exchange rate policy reports during the East Asian crisis suggest that its fixed exchange rate regime was forced to collapse due to the depletion of usable foreign reserves, which resulted from the credit policy of the Korean central bank to support domestic banks in need of foreign currency liquidity To capture the Korean crisis experience, I build a quantitative small open economy model in which, in response to the country risk premium shock, the foreign-currency credit policy of a central bank under fixed regime leads to the exhaustion of international reserves and consequent exchange rate regime shift This model does well at replicating the observed contraction in Korean aggregate variables
8 citations
TL;DR: In this article, the authors characterize the fiscal policy of the government when it levies distortionary taxes and issues defaultable bonds to finance its stochastic expenditure, and show that default is followed by temporary financial autarky.
Abstract: In a dynamic economy, we characterize the fiscal policy of the government when it levies distortionary taxes and issues defaultable bonds to finance its stochastic expenditure. Households predict the possibility of default, generating endogenous debt limits that hinder the government’s ability to smooth shocks using debt. Default is followed by temporary financial autarky. The government can only exit this state by paying a fraction of the defaulted debt. Since this payment may not occur immediately, in the meantime, households trade the defaulted debt in secondary markets; this device allows us to price the government debt before and during the default.
8 citations