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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
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TL;DR: In this article, the authors discuss the effectiveness of fiscal approaches to stabilization policy and argue that actual political systems are ill-suited to implement the advice from the theory, and monetary stabilization policy has been quite effective, making fiscal experiments redundant.
Abstract: The author discusses the effectiveness of fiscal approaches to stabilization policy. The conventional wis dom before 2007 was that fiscal policy intervention as a stabilization tool had little to recommend it, mostly due to political constraints and to the unlikely effectiveness of many types of temporary fiscal policy actions. However, with short-term nominal interest rates near zero, attention turned again toward fiscal stabilization policy. The author describes and critiques two theories of how fiscal policy might be viewed as effective in such circumstances. One, heavily studied, is that a tax-financed increase in govern ment expenditures would temporarily increase total output in the economy. The other, lightly studied but rhetorically forceful, is that increased government expenditures may inspire confidence. Both theo ries have drawbacks, but the author argues the first is dying because of three considerations: (i) actual political systems are ill-suited to implement the advice from the theory; (ii) monetary stabilization policy has been quite effective, making fiscal experiments redundant; and (iii) governments pushed distortion
5 citations
TL;DR: The authors show that government expenditures are procyclical in emerging markets and counter-cyclical on goods and services in developed economies, driven by differences in social transfers, and analyze how differences in tax policy and the nature of underlying inequality amplify or mitigate this result.
Abstract: Government expenditures are procyclical in emerging markets and counter-cyclical in developed economies. We show this pattern is driven by differences in social transfers. Transfers are more countercyclical and comprise a larger portion of spending in developed economies compared to emerging. In contrast, government expenditures on goods and services are quite similar across the two. In a small open economy model, we find disparate social transfer policies can account for more than a half of the excess volatility of consumption relative to output in emerging economies. We analyze how differences in tax policy and the nature of underlying inequality amplify or mitigate this result.
4 citations
Posted Content•
01 Jan 2020TL;DR: In this article, the authors study the relationship between political constraints and the probability of sovereign default on external debt using a dynamic stochastic model of fiscal policy augmented with legislative bargaining and default.
Abstract: I study the relationship between political constraints and the probability of sovereign default on external debt using a dynamic stochastic model of fiscal policy augmented with legislative bargaining and default. I find that political constraints and default probability are inversely related if the output cost of default is not too high. The model government comprises legislators who bargain over policy instruments, including over a local public good that benefits only the regions they represent. Higher political constraints are equivalent to more legislators with veto power over fiscal policies. This implies that during a default, the released resources need to be distributed among more regions as local public goods, with a smaller benefit accruing to each region, discouraging default. However, if default is too costly, even governments with lower political constraints default less frequently. Empirical evidence from South American countries is consistent with this result. I calibrate the infinite horizon model to Argentina. It confirms the negative relationship. A counterfactual exercise with even higher political constraints shows that the default by Argentina in 2001 could not be avoided.
4 citations
01 Jan 2014
TL;DR: In this paper, the authors show that the incentive to signal creditworthiness through austerity increases when sovereign credit ratings are less informative, and that increased scal austerity is associated with episodes in which ratings are more informative.
Abstract: Austerity measures may play a signalling role when sovereigns have private information about their ability to repay their debts. Reducing debt is less costly for more creditworthy countries, so by implementing a sucient degree of austerity they can avoid imitation by less creditworthy ones. In a separating equilibrium, more creditworthy countries suer from an ‘excessive’ debt reduction, but benet by being able to sell their debt at a higher price. The incentive to signal creditworthiness through austerity increases when sovereign credit ratings are less informative. Using a panel of 58 countries from 1980 to 2011, I nd that, consistent with the model, increased scal austerity is associated with episodes in which ratings are less informative.
4 citations