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Macroeconomic management and fiscal policy


									                                Thorvaldur Gylfason
         IMF Institute/Center for Excellence in Finance, Slovenia
Course on Macroeconomic Management and Financial Sector Issues
                                             Ljubljana, Slovenia
                                         September 21–29, 2011
1. Objectives and uses of fiscal policy
  Stabilization,   allocation, distribution
2. Global financial crisis and fiscal
   policy response
 Benefits and risks related to fiscal policy
    Public debt dynamics
    Sustainability of public debt
    Safeguarding fiscal sustainability

    Exit strategies when things go wrong

3. Fiscal reforms
1. The term fiscal policy refers to the use
   of public finance instruments to       Vito Tanzi
   influence the working of the economic
   system to maximize economic welfare
2. Effects of fiscal policy reflect not only
   the impact of the fiscal balance, but
   also various elements of taxation,
   spending, and budget financing
3. Assessing the stance of fiscal policy
   requires taking account of the activities
   of all levels of government
1. Stabilization
    Fiscal policy influences aggregate demand
        Directly because Y = C + I + G + X – Z
        Indirectly because C depends on income after tax
    Through demand, fiscal policy affects output,
     employment, inflation, balance of payments
2. Allocation
    Fiscal policy also influences aggregate supply
        Public infrastructure, education, health care
3. Distribution
    Through taxes, transfers, and expenditures
    Progressive, neutral, regressive
       Fiscal policy can be used to several ends
       To achieve internal balance
           By adjusting aggregate demand to available supply
           By achieving low inflation, potential output
       To promote external balance
           By ensuring sustainable current account balance
           By reducing risk of external crisis
       To promote economic growth
           E.g., through more and better education and health care
       Fiscal policy needs to be coordinated with
        monetary, exchange rate, and structural –
        i.e., supply-side – policies
  Demand management
              E.g., lower income taxes

                           Aggregate supply
                           in short run
Price level



  Demand management                             Supply management
              E.g., lower income taxes                        E.g., lower import tariffs

                           Aggregate supply
                           in short run                                      Aggregate supply
                                                                             in short run

                                                Price level
Price level



                                    Aggregate                                      Aggregate
                                    demand                                         demand

                                 Output                                          Output
                                                 Y = GDP
                                                 C = Consumption
                                                 I = Investment
                                                 G = Government expenditure
                                                   (plus lending minus repayments)
                                                 T = Taxes (plus grants)
       National income accounts                 X = Exports
                                                 Z = Imports
       Y=C+I+G+X–Z                              B = Government bonds outstanding
                                                 DG = Credit from banking system
       S = Y – T – C = I + G – T + X – Z, so    DF = Credit from foreigners
       G–T=S–I+Z–X
           Government budget deficit must be financed either by
            (a) having private saving in excess of private investment
            or (b) by accumulating foreign debt through a deficit in
            the current account of the balance of payments, or both
       Alternative formulation                       Inflationary v
       G – T = D B + D DG + D DF                     no ninflationary
           Government budget deficit must be financed by
            borrowing either at home or abroad, i.e., from (a) the
            public, (b) the banking system, or (c) foreigners
 Central      bank financing involves money creation
    Inflation tax: Most inflationary form of financing
 Bond      finance is less inflationary
    Removes financial resources from circulation
    Increases real interest rates
    Crowds out private investment
 External      financing can be inflationary
    Especially if it leads to currency depreciation
 Evidence       from cross-country data
    Strong links between budget deficits and inflation in
     developing countries, but not in industrial countries
        Bond finance is the rule in industrial countries …
        … and money finance is the exception
       Conventional budget surplus
                                                                                   not that
       T–G                                                      Problem here is
                                                                                     e but
                                                                 deficit is too larg
            Large in upswings when tax base (Y) is strong                            o low
                                                                that income is to
           Small in downswings when tax base is weak            Economic expan
                                                                  would automatic
       Full-employment surplus                                   turn deficit into
                                                T, G              from red to gree
       T –G
           Use tax revenue as it would be                                 T
            at full employment
           Independent of business cycles                                     G
           A budget in deficit could be in
            surplus with full employment
           Deficit can be consistent with
            a tight fiscal stance (see chart)
                                                       Y < YFE       YFE   Y
       Public sector borrowing requirement
       Broad measure of public sector deficit, including
        central, state, and local government
       Primary budget balance
       Leaves out interest payments
           Conventional deficit = G – T = GN + GI – T = GN + iDG - T
           Primary deficit = GN – T = G – T – iDG

                                                GN = Noninterest expenditure
                                                GI = Interest expenditure
                                                i = Nominal interest rate
                                                DG = Government debt outstanding
       Operational deficit                                      r≈i-p
       Leaves out inflation component of interest payments
           Operational deficit = conventional deficit minus inflation
            component of interest payments = primary deficit plus
            real component of interest payments
           Conventional deficit:                      GN = Noninterest expenditure
                                                       GI = Interest expenditure
             G – T = G + iD – T = G + (r + p)D – T
                       N     G        N         G
                                                       r = Real interest rate
           Operational deficit:                       DG = Government debt
                                                       p = Inflation rate
             G – T - pDG = GN – T + rDG
       Hence, operational deficit includes only real part of
        interest payments, leaves out the inflation part
       Before Great Depression 1929-39, many
        thought that governments needed to
        balance their budgets from year to year
       Even so, US had built is railways through
        borrowing, for example
       Keynes revolted (General Theory 1936)
         If private sector failed to consume and invest,
          government could fill the gap
        Y = C + I + G + X – Z

         C and I and G appear side by side

         Guns or butter? Makes no difference

         Also, could reduce taxes to encourage C and I
       Multiplier analysis
       It could be shown that, with unemployed
        resources, an increase in G would raise Y by an
        amount greater than the original increase in G
       Active fiscal policy was used consciously
        in Sweden even before Keynes …
       … and adopted in US and elsewhere after
        1960 (Kennedy-Johnson administration)
         Coincided with buildup of US as a welfare state
          with greater emphasis on public services and
          social security, like in Europe
         Active fiscal policy came naturally to Europe
       Fiscal policy can affect
       Aggregate demand, output, and price level
         Cut taxes: Consumption, output, and prices rise

       Rate of monetary expansion and inflation
         Increase spending financed by credit expansion:

          Money expands (M = D + R), so inflation goes up
       Aggregate supply and economic growth
         Boost infrastructure, education, and health

          care: Efficiency and long-run growth go up
       Current account of balance of payments
           Raise taxes: Disposable income and imports fall, so
            current account improves unless currency appreciates
       Fiscal multipliers are positive, but small
       Impact of fiscal policy actions depends on
       Whether economy is open or closed (import leakage)
       Exchange rate regime (fixed or floating)
       Type of budget financing (money creation or debt)
       Degree of confidence in economic policy
           Level of government debt outstanding
           Financing constraints
           Risk premia on debt
       Whether fiscal changes are considered temporary or
       How close the economy is to full employment
                                                   Will return to
         (-)              RE
        Gov’t Budget      (+)                              (-)
          Balance                                (+)
 (+)                       (-)   (+)
  Tax                                   (+)              (+)
revenue                Expenditure             Income            Interest Rate

                           (+)                             (-)
                          (-)    Investment
       Fiscal Policy
                                       (+)     Capital
    Monetary survey                M = Money supply
                                    R = Reserves (NFA)
                                    D = Domestic credit (NDA)
    M  =R+D                        DG = Domestic credit to government
     D = DG + DP                   DP = Domestic credit to private sector

        Fiscal policy determines government’s demand
         for bank financing (DG), which, in turn, affects
         total domestic credit (D), i.e., net domestic
         assets (ignoring other items net), and money (M)
     Increased budget financing requires
     greater monetary expansion unless credit
     to private sector (DP) is cut or foreign
     reserves (R) go down, reflecting a weaker
     balance of payments position
    In times of financial and economic
     crisis, fiscal policy plays key role in
     government’s response
     Fiscal policy played a role during Great
      Depression, even if theory behind it was
      poorly understood, or even disputed
     Fiscal policy plays key role in current crisis
      Monetary policy is ineffective if real interest
       rates cannot be reduced without igniting
      Fiscal policy is more effective
            Massive fiscal stimulus in US, Europe, and Asia: it works!
            Fiscal stimulus is assisted by automatic stabilizers
   Need for financing tends to lift
    interest rates, so capital flows in and
    currency tends to appreciate
   Central Bank must offset incipient
    appreciation by expanding money
    supply, thereby reinforcing initial
    fiscal stimulus
   Otherwise, exchange rate could not
    remain fixed                                      r
                          Fiscal stim ulus works unde
                              f ixed exchange ra
   Need for financing tends to lift
    interest rates, so capital flows in and
    currency appreciates
   Appreciation reduces net exports,
    aggregate demand, and interest rates
   Process continues until interest rates
    fall to their initial level        But concerte
                                       fiscal stimulu
   So, fiscal stimulus is ineffective can work even
    with perfect capital mobility       under floatin
                                           exchange rat
   times of large deficits and growing
 In
 public debt, public spending can have
 weak or even negative effects
  By creating expectations of a fiscal crisis,
   and hence of higher future taxes
  Increased saving may lead to a sharp fall
   in consumption
  Hence, fiscal stimulus can fail, and may
   even prove counterproductive
  Conversely, fiscal contraction may prove
   expansionary                       alence
                        Ric ardian equi
    Fiscal policy is frequently key to
     addressing balance of payments
    Simple mechanism
    M   = R + D means
      D R = D M – D D = D M – D DG – D DP
     Hence, given DM and DDP, key to raising
      DR is reducing DDG
     IMF: It’s Mostly Fiscal!
    Or look at it this way:
    Y  = C + I + G + X – Z means
     Hence, current account balance (X – Z) Z
      equals sum of private sector surplus of
      saving over investment (S – I) and
      government surplus of taxes over public
      expenditure (T – G)G
     Equivalently, Z – X = I – S + G – T means that
      external deficit equals sum of private sector
      deficit and government budget deficit
       Unsustainable fiscal policy can trigger a
        crisis if public loses confidence in
        government’s macroeconomic policy
     Sudden capital outflow can result, weakening
      the balance of payments and leading to a
      sharp devaluation
     Financing the budget externally builds up
      external debt, increasing risk of crisis
     Fiscal sustainability thus matters not only for
      debt, but also for balance of payments
 Fiscal contraction (spending cuts, tax
  increases) can slow down inflation,
  reduce current account deficit
 Fiscal expansion (tax cuts, spending
  increases) can shrink unemployment,
  increase aggregate demand and help
  restore output to full capacity, i.e.,
  bring actual GDP up to potential GDP,
  especially if monetary policy is
       Automatic, or built-in, stabilizers are
        revenue or expenditure provisions that
        have counter-cyclical impact without
        need for policy intervention
     Protect against shocks
     Dampen business cycles
       Examples
     Progressive taxes on income, profits
     Price stabilization funds
     Unemployment insurance
 Monetary   policy has been used heavily
 Its further impact may be limited
  In many countries, policy interest rates
   already approach zero
  Monetary policy may have limited effect
   during “balance sheet recessions,” when
   many firms are technically bankrupt, will
   use increased earnings to restore capital,
   and may not respond to lower interest
     Koo (2009), Holy Grail of Macroeconomics: Lessons from
      Japan’s Great Recession
 Mixed  evidence on efficacy of fiscal
  policy in developing countries
 While automatic stabilizing impulses
  are weak and make the case for
  discretion, there is also the widely
  noted occurrence of pro-cyclicality
  That is, government spending tends to
  rise during booms and to fall during
 The  focus of stimulus packages
  differs between advanced and
  developing countries
 Infrastructure spending 46% of fiscal
  stimulus in developing economies,
  but 15% in advanced economies
 Tax cuts over 34% of fiscal stimulus
  in advanced economies, only 3% in
  developing economies
    Khatiwada, S. (2009), “Stimulus Packages to Counter
     Global Economic Crisis; A Review,” International
     Institute for Labour Studies Discussion Paper 196.
                                                                     liers a
 No clear consensus among economists about
  the size of fiscal multipliers (response of
  real GDP to tax cuts or higher spending)
 Recent IMF Staff Position Note reports:
q   A rule of thumb is a multiplier (using the definition ΔY/ΔG and
    assuming a constant interest rate) of 1.5 to 1 for spending
    multipliers in large countries, 1 to 0.5 for medium sized countries,
    and 0.5 or less for small open countries.
q   Smaller multipliers (about half of the above values) are likely for
    revenue and transfers while slightly larger multipliers might be
    expected from investment spending.
q   Negative multipliers are possible, especially if the fiscal stimulus
    weakens (or is perceived to weaken) fiscal sustainability.
         Source: Spilimbergo, Symansky, and Schindler (2009), “Fiscal 
                        Multipliers,” IMF Staff Position Note spn/09/11. 
                               USD billion               % of GDP               Tax cut share (%)
  Brazil                               9                      0.5                          100
  Canada                              44                      2.8                           45
  China                              204                      4.8                            0
  France                              20                      0.7                            6
  Germany                            130                      3.4                           68
  Japan                              104                      2.2                           30
  India                                6                      0.5                            0
  Korea                               26                      2.7                           17
  Russia                              30                      1.7                          100
  Spain                               75                      4.5                           37
  UK                                  41                      1.5                           73
  US                                 841                      5.9                           35
                            Source: Eswar Prasad and Isaac Sorkin (Brookings Institution, 2009)
q Solvency
 §   Having enough assets to cover liabilities,
     and ability to service debts in long run
q Liquidity
 §   Ability to meet maturing obligations
q Sustainability
 §   Solvency + liquidity + no expectation of
     unrealistically large adjustment
q Vulnerability
 §   Risk of insolvency or illiquidity
Change in Canada’s per capita GDP from year to year 1871-2003 (%)
                                                             ext door?
                                        How about the U.S. n

                                    Canada had no major
                                    fa ilures during Great De
                                                             s Deposit
                                    and did not establish it
                                                              ntil 1967
                                    In surance Corporation u
                                                            on during Great
                                      Perhaps bank regulati
                                                                 abilize GDP
                                      Dep ression also helped st

Change in US per capita GDP from year to year 1871-2003 (%)
                                                             on during Great
                                       Perhaps bank regulati
                                                                  abilize GDP
                                       Dep ression also helped st

Change in UK per capita GDP from year to year 1871-2003 (%)

                                                             r capita
                                  t sta ndard deviation of pe
            Not quite as clear, bu                  % 1947-2003
            growth fell from 3.1% 1831-1945 to 1.8
                                                            on during Great
                                      Perhaps bank regulati
                                                                 abilize GDP
                                      Dep ression also helped st

Change in French per capita GDP from year to year 1821-2003 (%)
                                                           on during Great
                                     Perhaps bank regulati
                                                                abilize GDP
                                     Dep ression also helped st

Change in German per capita GDP from year to year 1851-2003 (%)
                                                            on during Great
                                      Perhaps bank regulati
                                                                 abilize GDP
                                      Dep ression also helped st

Change in Swedish per capita GDP from year to year 1821-2003 (%)

                                          Source: Maddison (2003).
       Objections to fiscal activism
       Borrowing to finance increased government
        expenditures raises interest rates, thereby
        crowding out investment and reducing multiplier
       At full employment, increased public spending,
        however financed, leads to inflation without
        stimulating output except temporarily
       Increasing spending or cutting taxes to combat
        unemployment may impart inflation bias to
        economic system
           Rules vs. discretion
           Long lags, including approval and implementation
       Fiscal activism may tend to expand public sector
       Fiscal stimulus packages need to
        include an exit strategy to ensure that
        solvency is not at risk, and should
       Not have permanent effects on budget deficits
       Provide a commitment to fiscal correction, once
        economic conditions improve
       Include structural reforms to enhance growth
       Should firmly commit to clear strategies for health
        care and pension reforms in countries facing
        demographic pressures
       Government has vital role to play in
        modern mixed economies (allocation role)
     Education
     Health care, cf. current debate in United States
     Infrastructure (roads, bridges, airports, etc.)
       Some would also stress government’s
        distribution role …
     … claiming that the government should try to
      secure reasonable equality in the distribution of
      income and wealth, including poverty alleviation
     Normative or positive economics?
           Partly positive: Equality is good for growth
 Two  views
                        r = -0.27
 Inequality sharpens
  incentives and thus
  helps growth
 Inequality
  endangers social
  cohesion and hurts
 117 countries,
 Equality   is good for
  growth                   r = -0.27
 No visible sign here
  that equality stands
  in the way of
  economic growth
 An increase in Gini
  index by 16 points
  goes along with a
  decrease in per
  capita growth by
  one percentage
  point per year
       Why not raise government expenditure
        on public services or whatever and
        reduce taxes? – to buy votes
        Supposing all objections could be swept aside
     Because this would create a deficit and
      deficits can lead to inflation, and inflation is
      undesirable for many reasons – it reduces
      efficiency and growth, for one thing
     Even so, a modest deficit can be sustained in
      a growing economy
     So how modest is modest?
 Debtaccumulation is, by its nature,
 a dynamic phenomenon
  A large stock of debt involves high
   interest payments which, in turn, add
   to the deficit, which calls for further
   borrowing, and so on
    o   Debt accumulation can develop into a
        vicious circle
   How do we know whether a given debt
   strategy will spin out of control or not?
    o   To answer this, we need a little arithmetic
Revenues          Expenditures

      Budget Deficit


     Increase in debt

 Higher interest payments
 Recall   operational budget deficit:
  G – T = DB + DDG + DDF = DD = GN + rD - T
  where D is total government credit outstanding
 Further,   assume for simplicity
  T = GN
 Then,    we have
  DD = rD
 This   gives
So, now we have:

Now subtract growth rate of output from
both sides:
But what is


This is proportional change in debt ratio:

                      This is an application of a
                      simple rule of arithmetic:

                      %D(x/y) = %Dx - %Dy
z = x/y
log(z) = log(x) – log(y)
Dlog(z) = Dlog(x) - Dlog(y)
But what is Dlog(z) ?

       So, we obtain

We have shown that   Defic its can be sustained a
                                              s not
                     long as debt ratio doe
                                                ., at
             Debt    s pin out of control – i.e
             ratio   least as long as g > r


We have shown that   Need economic
                     growth to keep debt
             Debt    ratio under control


We have shown that   Higher interest rates
                     can turn a sustainable
             Debt    debt position into an
             ratio   unsustainable one



                           Primary deficit = GN – T = G – T – iDG
                           Primary balance: PB = T – G + iDG

   Take another look
   Intertemporal budget constraint:

   Dividing by nominal GDP (= PY), we get

                         If r > g, d rises over time
                         If r = g,  d remains uncha
                          If r < g, d declin
   We have seen that           Reducing primar
                                d eficit is key to
                                red ucing debt ratio
   To find where debt ratio is headed,
    i.e., the long-run equilibrium value of
    d, we set dt = dt-1; this gives
                          pb < 0 m eans that primar
                          budget b alance is in defic

      > 0 if pb < 0 and g > r
   To improve primary balance
     Raise    and reform revenue
      ü   Raise taxes and fees
      ü   Reform revenue collection by levying
          efficient taxes and fees
           ü   E.g., pollution fees rather than income taxes
      ü   Improve tax administration
     Reduce     and reform expenditure
      ü   Emphasize efficiency
      ü   Avoid waste
       Adequacy
       Taxes must be consistent with budgetary needs
        and with revenue generating capacity
       Simplicity
       Tax rules must be easy to understand and
        entail low administrative and compliance costs
       Fairness
       Tax system must ensure that equals pay the
        same and rich pay more than poor
       Efficiency
       Tax policy must minimize distortions and
       Broad base improves efficiency
       Limit holidays, exemptions, deductions, etc.
       Simple rates ease administration
       Use single or few preferably ad valorem rates
       Excessively high rates are ineffective
       Use moderate internationally comparable rates
       Pay attention to economic tax incidence
       Consider long-term consequences
    Revenue from broad-based sales tax
     Specifically,   value added tax (VAT)
    Little reliance on trade taxes
    Simple personal income tax
    Corporate tax at single, low rate
    An elastic tax system
       VAT
     Single rate of 10-20%
     Few exemptions
       Trade taxes
       Low uniform tax on imports
           For protection, not revenue
       Avoid taxes on exports
       Income taxes
     No more than three brackets,
     Top marginal rate of no more than 40%
     Limited exemptions
       Corporate tax
     Single proportional rate of 30-40%
     Equalize top marginal rate of personal and
      corporate income taxes
           Prevents tax avoidance through choice of
            corporate or non-corporate form
       Few exemptions
       Elastic tax system
       Ensures that tax revenues will increase as
        economy grows
                                 Early 1990's    Early 2000's
Americas                              13               16
Sub-Saharan Africa                     2                9
Central Europe and the BRO             1               14
Africa and the Middle East             3                5
Asia and the Pacific                   4               11
Small Islands                          0                2

Total number of developing
countries with a VAT                  23               57

Source: Keen and Simone, 2004.
                                 1990-91       2000-01

Americas                           4.9           2.2
Sub-Saharan Africa                 9.0           8.1
Central Europe and BRO             4.7           1.5
North Africa and Middle East       5.9           5.7
Asia and Pacific                   6.3           2.7
Small Islands                     10.1           8.4

      Developing countries         6.5           4.2
      High-income countries        3.1           1.2

Source: Keen and Simone, 2004.                           64
Source: Keen and Simone, 2004.
Source: Keen and Simone, 2004.
Essentials of Tax Administration Reform
 Explicit   and sustained political commitment
 Team   of capable officials
 Well-defined    and appropriate strategy
 Relevant    training for staff
 Adequate    resources for tax administration
 Changesin incentives for taxpayers and tax
 United   States
  Replace current income tax code by
   uniform flat tax or by national sales tax
 Europe
  Lower domestic tax rates to stimulate
   moribund economies
 Latin   America and Asia
  Lower tariffs to improve competitiveness
   at home
    Compensate for market failure
     Externalities (education, health care)
     Public goods (national defense, air)
     Collective goods (fish)
     Social insurance
    Support private sector development
     Education
     Health  care
     Infrastructure
       Affordability
       Level of public expenditure must be consistent
        with revenue and financing constraints
       Efficiency
       Appropriate mix of goods and services at lowest
        possible cost
       Priorities
       Expenditure priorities must be defined in
        accordance with economic goals
           Are expenditures productive?
       Equity
       In line with distributional objectives and poverty
        alleviation goals
   Public wages and employment
   Provide adequate operations and
    maintenance spending
   Eliminate subsidies and target
   Minimize military expenditure
   Encourage capital expenditures
   Eliminate unproductive spending
                           Average    Ratio of 
                           central    public to 
                                                 employment as 
                         government  private 
                                                 percent of total 
                         wage to per   sector 
                         capita GDP    wages
Asia                         3.0         0.8           56.7
Eastern Europe and 
Central Asia                 1.3         0.7           54.6
Latin America and 
Caribbean                    2.5         0.9           20.9
Middle East and North 
Africa                       3.4         1.3           53.7
Sub-Saharan Africa           5.7         1.0           37.8
OECD 1/                      1.6         0.9           23.0
Sources: World Bank, ILO, and OECD. 
Data refer to 1996 - 2000 average.
       Identify white elephants
       Look for proximate indicators of
     Literacy rates
     Mortality rates
       Identify sectoral expenditure imbalances
       E.g., high teacher/pupil ratio with
        inadequate teaching supplies
       Identify allocative inefficiency
       E.g., generalized subsidies
    Avoid across-the-board cuts
     Be selective
     Target needed cuts
    Consider capacity for efficient
     project realization
    Focus on medium-term rather than
     one-shot measures
    Emphasize sound incentives,
     targeting, and transparency
    Address budget rigidity
    Address fiscal federalism
    Use fiscal policy to promote
     economic growth
     Long-rungrowth is endogenous, and
     responds to fiscal and monetary policy
      Monetary policy?
      Yes, because low inflation is good for
       economic growth
       Many countries face budgetary problems
        from mandatory expenditures
       Creating automatic outlays, without needing
        formal approval by the government
       Examples
     Loan guarantees
     Public pensions, health insurance, jobless
     Deposit insurance programs
     Tax expenditures
           Automatic reductions in tax liability for those with
            qualifying expenses
       Challenge is to reduce pre-committed
       Some options are
       Limit tax expenditures
           Put ceilings or require minima on amount of expenses
            qualifying for deductibility from taxable income
       Reform public pension programs
           Consider shifting to basic minimum benefit plus
            mandatory saving (defined contribution plan)
           U. K. (minimum benefit), Chile (more extensive reforms)
       Limit loan guarantees and deposit insurance
           Insurance should not provide 100% coverage
       Many countries allocate expenditure
        responsibilities to multiple levels of
       Advantages
           May be more responsive to local needs
           Possibly better management
             Subsidiarity principle
       Disadvantage
           May be harder to control fiscal performance as a
       Challenge is to ensure adequate funding
        for services at all levels while achieving
        overall fiscal objectives
    Different countries have different
     ways of maintaining discipline
     Balanced  budget rules (common in US)
     Restrictions on borrowing by state and
      local governments (common in Brazil,
    Look for enforceability of
     restrictions and ability of sub-
     federal units to evade limits
       Tax policy
       Consistent with investment-friendly business
        climate and adequate funding for government
       Expenditure policy
       Supply productive “public goods”
       Address externalities efficiently
       Restrict monopolies, promote competition
       Foster good governance, rule of law
       Provide financial regulation and safety nets
       Support private sector activity while focusing on
        those things that government can do better than
        private sector
       Avoid inflation, inefficiency, excessive inequality
       Creating an investment-friendly tax
       Moderate overall tax burden that allows
        financing efficient levels of government activity
       Focus taxes on consumption rather than income,
        to reduce double taxation of savings
           Modest income tax
           Limiting payroll tax burden
           Keeping corporate profit taxes modest
       Address double taxation of dividends
       Keep tax burden competitive with neighboring
        and comparable jurisdictions; may require
        moderating corporate profit tax rate
       Be serious about stabilization, allocation,
        and distribution
       Keep spending consistent with revenue levels, to
        avoid heavy debt and debt service levels
       Build and maintain productive infrastructure
       Maintain effective education system
       Maintain cost-effective health care system
       Maintain impartial and effective courts
       Maintain appropriate regulatory environment,
        especially for financial sector and other sectors
        with important economy-wide externalities
       Also, encourage private sector
 Sound  fiscal policy is critical for good
  macroeconomic management, and can
  help manage capital flows
 Fiscal stimulus is usually expansionary,
  but not invariably
 Fiscal policy crucially affects BOP, and
  interacts with monetary policy
 Fiscal policy, as before, is crucial to
  responding to financial crises
    Especially when monetary policy lands in
     liquidity trap and loses traction
 Fiscal   policy can help foster rapid growth

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