The views expressed in this article are those of the author and do not necessarily represent those of the Banque de France or the Eurosystem.
Sovereign Debt and Fiscal Policy in the Aftermath of the Financial Crisis: Introduction
Article first published online: 26 FEB 2013
© 2013 The Author(s). The Economic Journal © 2013 Royal Economic Society
The Economic Journal
Volume 123, Issue 566, pages F1–F3, February 2013
How to Cite
Bussière, M. (2013), Sovereign Debt and Fiscal Policy in the Aftermath of the Financial Crisis: Introduction. The Economic Journal, 123: F1–F3. doi: 10.1111/ecoj.12009
- Issue published online: 26 FEB 2013
- Article first published online: 26 FEB 2013
The recent financial crisis has posed key challenges for policy makers. The conference on ‘Fiscal and Monetary Policy in the Aftermath of the Financial Crisis’ that took place in Paris on 8th and 9th of December 2011 aimed at bringing together prominent researchers and academics to discuss these challenges and to present frontier research. It was organised by the Banque de France, the Paris School of Economics, the Euro Area Business Cycle Network (EABCN) and the Economic Journal. The articles presented in this volume focus on issues related to sovereign debt and fiscal policy.
Following the outbreak of the crisis, the budget deficits of emerging markets and especially advanced economies have risen to historically high levels, under the effects of automatic stabilisers and countercyclical policies. According to the IMF World Economic Outlook statistics, the cumulated deficits of advanced countries rose from 1.1% of GDP in 2007 to 6.5% in 2011 (for emerging market and developing economies the rise was smaller but still sizable, from a surplus of 1.3% to a deficit of 1.1%). Correspondingly, gross government debt levels have increased by 30 percentage points of GDP in advanced economies between these two dates, reaching 103% of GDP in the United States, 230% in Japan, 83% in the United Kingdom and 88% in the euro area. At the same time, financial markets have become reluctant to buy government debt, particularly in European states from the so-called periphery, where interest rate spreads to German government bonds have risen sharply (by over 3,000 basis points in Greece, 1,400 in Portugal, 500 in Ireland and about 400 in Spain and Italy, for 10-year bonds). This has led fiscal authorities to undertake fiscal consolidation programmes to regain full market access and contain government spreads. These noticeable developments have reopened some long standing issues in fiscal policy, making this feature a timely publication. This feature consists of the following six articles.
In their article ‘Fiscal Fatigue, Fiscal Space and Debt Sustainability in Advanced Economies’, Atish R. Ghosh, Jun I. Kim, Enrique G. Mendoza, Jonathan D. Ostry and Mahvash S. Qureshi propose new measures for the maximum public debt level that is compatible with fiscal solvency.1 They define the concept of ‘debt limit’ as the level beyond which fiscal solvency is in doubt, while ‘fiscal space’ refers to the distance between the current debt level and the debt limit. The authors proceed with a theoretical model featuring a government that displays ‘fiscal fatigue’ (namely, it is not able to run primary balances that keep pace with rising debt). This model allows them to derive the ‘debt limit’ formally. Next, empirical support for key features of the model is presented using panel data for 23 advanced economies over 1970–2007.
In ‘Uncertain Fiscal Consolidations’, Huixin Bi, Eric M. Leeper and Campbell Leith explore the macroeconomic consequences of fiscal consolidations. They show that these effects vary significantly, depending on a variety of factors including the nature of fiscal consolidation, its duration, its composition, the monetary policy stance, the level of government debt and the expectations over its likelihood. This suggests, for policy purposes, that simple rule-of-thumb multipliers are likely to be very misleading, because they typically do not distinguish across these different factors. This article also helps to explain why the empirical literature on the macroeconomic effects of fiscal consolidations is inconclusive (it is indeed very difficult to account for these effects empirically).
The article – ‘Public Debt and Redistribution with Borrowing Constraints by Florin Bilbiie, Tommaso Monacelli and Roberto Perotti’ – deals with the re-distributional aspects of public debt. This is an issue of high policy and academic importance because the stimulus packages adopted in the wake of the financial crisis have often taken the form of transfers to specific income groups, and are often associated with an upward trend in debt. The authors develop a model economy with heterogenous agents (savers and borrowers), and study the effects of public debt by linking it to the redistribution that it implies, within and across periods. They show that under flexible prices both redistribution and deficit-financed uniform tax cuts have either no effects or effects that are inconsistent with empirical evidence. With nominal rigidity, however, both redistribution (from savers to borrowers) and uniform tax cuts are expansionary.
Giancarlo Corsetti, Keith Kuester, André Meier and Gernot J. Müller consider the interaction between fiscal policy, monetary policy and macroeconomic stability in their article ‘Sovereign Risk, Fiscal Policy, and Macroeconomic Stability’. One key aspect they consider relates to so-called indeterminacy problems, through which private-sector beliefs may become self-fulfilling. They show in particular that these problems arise when monetary policy is constrained and sovereign risk is high. Under those conditions, fiscal consolidations have an important role to play in mitigating the risks of macroeconomic instability and may even stimulate economic activity, as fiscal multipliers change sign relative to ‘normal times’.
The fact that fiscal multipliers are not fixed and constant but depend in a complex way on the interaction between fiscal and monetary policy and the macroeconomic environment is also a key feature of the article entitled ‘Deficits, Public Debt Dynamics and Tax and Spending Multipliers’, by Matthew Denes, Gauti B. Eggertsson and Sophia Gilbukh. In this article, the authors make the important point that when the nominal interest rate is close to zero (a key feature in many countries during the recent financial crisis), a cut in government spending can actually increase the budget deficit. This somewhat counterintuitive result arises in a standard New Keynesian DSGE model calibrated with Bayesian methods and calls for caution in proceeding with fiscal consolidation, as the outcome could depend very much on the policy regime and on expectations about the future course of policy.
Finally, Elisa Faraglia, Albert Marcet, Rigas Oikonomou and Andrew Scott turn to the interaction between government debt and the optimal rate of inflation in their article entitled ‘The Impact of Government Debt Maturity on Inflation’. This article considers the role of inflation for debt stabilisation when governments issue longer term nominal non-contingent debt. Costs of price adjustment are such that distortionary taxes smoothed over time are preferable to higher levels of inflation.
This article was not part of the conference.