Discussion of
Forni and Pisani’s
“Expansionary Fiscal Policy and the Trade Balance:
Evidence from a Bayesian DSGE model
for the euro area”
by
Giancarlo Corsetti
(European University Institute and CEPR)
2nd BANK OF ITALY CONFERENCE ON
MACRO MODELING IN THE POLICY ENVIRONMENT
Banca d’Italia 30 June-1 July, 2009, Rome, Italy
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Pressing questions and recent debates
• Fiscal policy
- Size and sign of the multiplier (under what conditions)?
Counterproductive?
- Interaction with (conventional and unconventional)
monetary policy
- International spillovers (demand leakages and exchange
rate)? Need for coordination?
• But what is the transmission mechanism? Some recent VAR
results have revived old debates (consumption multiplier)
but also questioned received wisdom on the transmission
mechanism:
- Exchange rates: evidence of depreciation in response to
positive spending shock for the US (and other countries)
- (Interest rate)
- Twin deficits: for the US, evidence is mixed.
2
What does the paper do
• Drawing on Adolfson et al. (2007) and Coenen et al. (2008)
use Bayesian open economy DSGE model to assess the
quantitative effects of fiscal shocks in the euro area vis-à-vis
a (relatively more closed) foreign region (with no spillovers
from the home region)
• Model is rich on the fiscal side (spending, taxes), and
accounts for financial frictions including ‘hand-to-mouth
consumers’
• focus on two key dimensions: trade balance and
international prices (real exchange rates)
• Preliminary, yet nice job!
3
Main results
• Adds to skepticism on fiscal stabilization
- Output multiplier almost never above one
- Investment is crowded out in response to spending and
transfers shocks, although is mildly crowded in by
temporary reduction in taxes
- Consumption multiplier are negative in response to
temporary hikes of spending on final goods and taxes on
final goods; contained if temporary public transfers
- consumption response is strong in response to temporary
reduction in labour and consumption taxes
=> Stress on the need for a sharper understanding of
transmission (more later)
• Specific contribution to debate
- Find twin deficits for spending and transfers
- Terms of trade appreciate in response to shocks to
spending, transfers, capital income taxes (depreciates
with cuts in wage and consumption taxes)
4
Focus of my comments: Exchange Rates
• I focus on exchange rates. First some evidence. I draw from
ongoing work with Gernot Mueller and Andre Meier.
•
VAR evidence on the response of Spending shocks (augmented
Blanchard-Perotti) for the US:
5
More evidence
• VAR evidence on the response of Spending shock for a sample
of OECD countries (annual data)
6
What is at stake? Theory
Which model predicts a real exchange rate (terms of trade)
depreciation in response to spending shocks?
• Not a new issue: dubbed embarrassing failure of the Mundell
Fleming model, by e.g. Dornbusch 1980
• Should we amend the standard GE models?
- F. Bilbiie; T. Monacelli and R. Perotti (among others)
stress complementarity between consumption and
employment.
- M. Ravn, S. Schmidt-Grohe and M. Uribe emphasize ‘deep
habits’ in government consumption.
• Should we rethink the way we model fiscal policy?
- Joint work with A. Meier and G. Mueller: stress on
medium-term fiscal framework (spending reversals)
7
What is at stake? Empirics
• Is depreciation specific to the US (UK, Canada and Australia,
or to our sample average)?
- Beetsma, Giuliodori and Klaassen report real
appreciation for European countries
- CMM provide some evidence that the transmission of
spending is associated with appreciation under fixed
exchange rates
• Is depreciation a by-product of mis-specification?
- However, depreciation seems to be detected also using
Ramey’s approach to identification
8
A key question
• Can (estimated) DSGE models like the one in the paper shed
light on the above issues, both theoretically and empirically?
• The model imposes lots of structure on the data. The
question is whether it is given a change to let the data ‘pick
the winner’ among alternative transmission mechanisms
• In the specification proposed in the draft, transmission is
textbook. In response to spending and transfer shocks:
- Consumption by ricardian households is crowded out
- Non-ricardian consume more but not enough to drive
aggregate consumption up
• Why? The standard answer is ‘wealth effects’.
• But note that ricardian consumption rises in response to
temporary cuts in consumption and wage taxes!
9
A theoretical reconsideration
• In present discount value, the change in the tax burden due
to the assumed temporary increase in spending and transfer
is minuscule (zero in the tax experiments)
• What matters is the change in the intertemporal price of
consumption and investment
• Consumption euler equation: Change in the real return on a
very long-term zero coupon bond
• With ricardian agent and a high degree of risk sharing, for a
given the foreign monetary stance, this is mirrored by the
rate of depreciation
 consumption, long real rate, real exchange rate
• In Figures 2-5 of the paper, appreciation is mirrored by a fall
in ricardians’ consumption
• Interplay between fiscal shocks and asset prices
10
Spending reversals
Let’s play the same theoretical tune in a different way
• As an empirically promising instance, embed in the model
endogenous dynamic correction of current deficits (actually
in the paper, eqs. 19-21)
- Mix of cuts in spending (below trend) and rise in taxes
(debt sensitivity of spending and taxes)
If current spending shocks are partially reversed over time
• Anticipation of future spending cuts tends to lower future
short real interest rates
• If prices are flexible, current long real rate rises
nonetheless: consumption of ricardian households fall
• With nominal rigidities, under a Taylor rule larger
adjustment in output: current long real rate may fall:
consumption of ricardian households rise
11
Exogenous spending shocks/or no reversal
12
Endogenous fiscal policy: reversals
13
Spending reversals: flex price
14
Spending reversals: nominal rigidities
15
Including hand-to-mouth consumers
16
Taking stocks
• Explore more the issue of endogenous debt correction
dynamics
• There is empirical evidence on debt sensitivity of spending
(fiscal rule)
• For the US, one can estimate coefficients between -.02 and .03
• The model does pick this up for the euro area. But effect is
swamped by autoregressive coefficient
17
Matching impulse responses (US)
18
More to be done (policy and theory)
• Endogenous dynamic of budget (tax and spending) policy
has direct bearing on policy
• Addresses issues raised by zero bound (see Christiano
Eichenbaum and Rebelo; Eggertsson)
• The model could be extended along other lines
- Non separability (Bilbiie, Monacelli-Perotti effects)
- Deep habits
• Report long rates!
19
Only a word on twin deficit/divergence
• Difficult issue raised by Kim and Roubini. Once again:
- Faulty theory?
- Faulty empirical specification?
• Once again, as is the model is geared towards generating
twin deficits
20
Conclusion
• Authors have setup a very good framework to address key
issues in the current debate on fiscal policy
• Results so far suggest that textbook model of fiscal
transmission can somehow frame the data for the euro area
- But what is the measure of success?
• Yet the model could do much more --- embed alternative
transmission channels debated by recent literature
• Looking forward to see future versions of it
21
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Concept diagrams available after slide 40