pushing the limit fiscal policy in the european monetary union abstract governments are confronted with the growing realization that they face fiscal limits on the size of debt and deficits relative to gdp these fiscal limits invalidate bohn s criterion for fiscal sustainability which allows explosive debt relative to gdp eventually violating any fiscal limit we derive restrictions on a fiscal rule necessary for the government to eliminate explosive behavior these restrictions require that the response of the primary surplus to debt be relatively strong and that the primary surplus be cointegrated with both debt and output we test these empirical implications for a panel of eleven emu countries and find that they are satisfied implying that fiscal policy does not create explosive behavior

a graceful return of the drachma abstract a country participating in a monetary union is constrained by loss of control over seigniorage revenue once the government reaches its fiscal limit on ordinary taxation it cannot turn to seigniorage for financing we show that a monetary union country can increase its seigniorage revenue by reissuing its own currency even as it fully honors all outstanding debt obligations we use a simple cash in advance model with domestic currency demand motivated by the need to pay taxes to show that this policy effectively redistributes seigniorage revenue away from other monetary union members toward the acting country the magnitude of the seigniorage created by currency reissue is limited both by the relative size of the country and by money demand and therefore by the tax base if this seigniorage revenue is insufficient some additional seigniorage is available by allowing the new currency to grow and depreciate over time and domestic real wages to fall

on identification of bayesian dsge models this article is concerned with local identification of individual parameters of dynamic stochastic general equilibrium dsge models estimated by bayesian methods identification is often judged by a comparison of the posterior distribution of a parameter with its prior however these can differ even when the parameter is not identified instead we propose two bayesian indicators of identification the first follows a suggestion by poirier of comparing the posterior density of the parameter of interest with the posterior expectation of its prior conditional on the remaining parameters the second examines the rate at which the posterior precision of the parameter gets updated with the sample size using data simulated at the parameter point of interest for an increasing sequence of sample sizes t for identified parameters the posterior precision increases at rate t for parameters that are either unidentified or are weakly identified the posterior precision may get updated but its rate of update wi

common trends the government s budget constraint and revenue smoothing abstract the requirement that the government s budget be balanced in present value terms is shown to be equivalent to the condition that government expenditures inclusive of interest tax receipts and seignorage be cointegrated the condition is in fact stronger requiring that the deficit inclusive of interest be stationary stationarity of the net of interest deficit is neither necessary nor sufficient for intertemporal budget balance however it does have implications for barro s tax smoothing hypothesis data for the period 1890 1986 are consistent with intertemporal budget balance but not with tax smoothing

international evidence on fiscal solvency is fiscal policy responsible abstract we conduct a cross country empirical analysis of fiscal solvency based on dynamic stochastic general equilibrium conditions the results show evidence of fiscal solvency in the form of a robust positive conditional response of the primary balance to changes in public debt in panels for emerging and industrial economies and in a combined panel emerging economies show a stronger response and hence converge to lower mean debt output ratios as observed in the data the results are weaker for countries with debt ratios exceeding panel means and medians hence we can separate countries where fiscal solvency holds from those where it remains in doubt

periodically expanding discounted debt a threat to fiscal policy sustainability this paper models the behaviour of discounted us debt using a markov switching time series model the significance of modelling fiscal policy within this framework derives from the implications it has for long term sustainability the two regime framework used in this paper identifies periods where the present value of us federal debt is expanding versus periods when it is collapsing using an updated data series from hamilton and flavin 1986 a test is conducted to establish if the expanding periods pose a threat to the long run sustainability of fiscal policy for the usa it is found that they do not copyright 2005 john wiley sons ltd

the sustainability of government deficits implications of the present value borrowing constraint this paper introduces a new methodology for evaluating the sustainability of fiscal policy the new methodology is distinguished from most existing tests in two important respects first it allows for stochastic real interest rates and second it is both necessary and sufficient results from the application of the new test suggest that recent fiscal policy in the united states has not been sustainable the paper contrasts its findings with those of james d hamilton and marjorie a flavin 1986 copyright 1989 by ohio state university press

determinacy and identification with taylor rules the new keynesian taylor rule theory of inflation determination relies on explosive dynamics by raising interest rates in response to inflation the fed induces ever larger inflation unless inflation jumps to one particular value on each date however economics does not rule out explosive inflation so inflation remains indeterminate attempts to fix this problem assume that the government will choose to blow up the economy if alternative equilibria emerge by following policies we usually consider impossible the taylor rule is not identified without unrealistic assumptions thus taylor rule regressions do not show that the fed moved from passive to active policy in 1980

testing for indeterminacy an application to u s monetary policy reply this paper considers a prototypical new keynesian model in which the equilibrium is undetermined if monetary policy is passive the likelihood based estimation of dynamic equilibrium models is extended to allow for indeterminacies and sunspot fluctuations we construct posterior weights for the determinacy and indeterminacy region of the parameter space and estimates for the propagation of fundamental and sunspot shocks according to the estimated model u s monetary policy post 1982 is consistent with determinacy whereas the pre volcker policy is not we find that before 1979 indeterminacy substantially altered the propagation of shocks

u s deficits since world war i the tax smoothing theory suggests that deficits would respond particularly to recession temporarily high government spending and anticipated inflation my empirical estimates indicate that a relation of this type is reasonably stable in the u s since at least 1916 in particular the statistical evidence does not support the idea that there has been a shift toward a fiscal policy that generates either more real public debt on average or that generates larger deficits in response to recessions further the deficits for 1982 3 and popular projections formed in 1984 for 1984 5 are consistent with the previous structure the high values of these deficits reflect the customary response to substantial recession interacting with big government and to expected inflation

sustainability of the deficit process with structural shifts this article discusses the condition for deficit sustainability and searches for shifts in the structure of u s deficit policy i show that contrary to the current literature cointegration between revenues and expenditures inclusive of debt payment is not a necessary but a sufficient condition for a strict interpretation of deficit sustainability the necessary condition requires that debt grow slower than the borrowing rate for tests on structural shifts i use a test for structural change that searches for shifts in the rank of the cointegrating matrix i find that there is a shift in deficit policy in the early 80s so that cointegration between revenue and expenditure inclusive of interest payments holds only up to 1980 i show however that the deficit process is still sustainable despite the failure of cointegration in the 80s the finding of shifts in the deficit process is more uncertain when i normalize by gross national product or population but the deficit is shown to be sustainable regard

fiscal space and sovereign risk pricing in a currency union abstract we examine how membership in a currency union affects public debt sustainability and market assessments of default risk in eurozone countries we argue that there exist offsetting effects expectations of bailouts tend to make a given level of debt more sustainable lowering bond yields and cds rates but constraints on the use of monetary policy would tend to have the opposite effect pushing rates up especially as room for fiscal maneuver gets exhausted we develop a formal concept of fiscal space which takes account of the notion of fiscal fatigue under which there are limits to the government s ability to raise the primary surplus in response to higher debt and apply it to the eurozone countries investigating in particular how currency union membership affects cds and bond rates during both quiet and turbulent times for a given amount of fiscal space we find that in quiet times cds and bond rates for eurozone members were below what would be expected given their fiscal space a bonus from currency union membership but when the crisis erupted cds and bond yields rose more sharply for eurozone members than would be predicted based on their available fiscal space our interpretation is that sovereign bailouts did not occur with the hoped for alacrity in euro crisis countries generating sharper penalties for sovereigns that belong to a currency union

evaluating the information matrix in linearized dsge models abstract in this note we show how the stochastic general equilibrium dsge models can be evaluated analytically the result is useful for the estimation and identification analysis of such models

on the limitations of government borrowing a framework for empiricaltesting this paper seeks to distinguish empirically between two views on the limitations of government borrowing according to one view nothing precludes the government from running a permanent budget deficit paying interest due on the growing debt load simply by issuing new debt an alternative perspective holds that creditors would be unwilling to purchase government debt unless the government made a credible commitment to balance its budget in present value terms we show that distinguishing between these possibilities is mathematically equivalent to testing whether a continuing currency inflation might be fueled by speculation alone or is instead driven solely by economic fundamentals empirical tests which have been developed for this economic question lead us to conclude that postwar u s deficits are largely consistent with the proposition that the government budget must be balanced in present value terms this abstract was borrowed from another version of this item

weak instrument robust tests in gmm and the new keynesian phillips curve we discuss weak instrument robust statistics in gmm for testing hypotheses on the full parameter vector or on subsets of the parameters we use these test procedures to reexamine the evidence on the new keynesian phillips curve model we find that u s postwar data are consistent with the view that inflation dynamics are predominantly forward looking but we cannot rule out the presence of considerable backward looking dynamics moreover the phillips curve has become flatter recently and this is an important factor contributing to its weak identification

a guide to public sector debt and deficits government deficits reinterpreted willem h buiter public sector debt and deficits are a matter of concern to governments throughout the world after presenting data on the public debt and deficits in the uk and abroad this paper considers four key issues first does an increase in the budget deficit today make an increase in inflation in the future more likely in economies like the uk the answer is no because the scope for raising revenue by money creation is limited compared to raising taxes second how does one evaluate the consistency of a given spending and tax programme a number of measures are presented which indicate the adjustment that must be made to spending and tax plans if the government is to remain solvent third it is often argued that an increase in budget deficits will merely crowd out private spending the paper shows that the truth of this proposition depends critically on the state of the economy the time horizon and whether the increased deficit is temporary or permanent finally the question of deriving a suitable measure of fiscal stance is considered developing an index of fiscal impact requires a suitable economic model and a number of different measures are considered and criticized conventional deficit measures whether actual cyclically corrected or inflation corrected are a poor indicator of the government s true fiscal stance

the identification of rational expectations models under structural neutrality abstract this note shows that in the structural neutrality version of the linear rational expectations model the parameters measuring the strength of response to unanticipated shocks cannot be identified in the absence of restrictions on the covariance properties of the structural disturbances the consequences of this result for the commonly used two step estimation method are explored

measuring prior sensitivity and prior informativeness in large bayesian models abstract in large bayesian models such as modern dsge models it is difficult to assess how much the prior affects the results this paper derives measures of prior sensitivity and prior informativeness that account for the high dimensional interaction between prior and likelihood information the basis for both measures is the derivative matrix of the posterior mean with respect to the prior mean which is easily obtained from markov chain monte carlo output we illustrate the approach by examining posterior results in the small model of lubik and schorfheide 2004 and the large model of smets and wouters 2007

are stationarity and cointegration restrictions really necessary for the intertemporal budget constraint abstract time series related to fiscal and external deficits are commonly subjected to stationarity and cointegration tests to assess if the deficits are sustainable such tests are incapable of rejecting sustainability the intertemporal budget constraint proves to be satisfied if either the debt series or the revenue and with interest spending series are integrated of arbitrarily high order i e stationary after differencing arbitrarily often revenues and spending do not have to be cointegrated rejections of low order difference stationarity and of cointegration are thus consistent with the intertemporal budget constraint error correction type policy reaction functions are suggested as more promising for understanding deficit problems

identifying the new keynesian phillips curve phillips curves are central to discussions of inflation dynamics and monetary policy the hybrid new keynesian phillips curve nkpc describes how past inflation expected future inflation and a measure of real aggregate demand drive the current inflation rate this paper studies the potential weak identification of the nkpc under generalized method of moments and traces this syndrome to a lack of higher order dynamics in exogenous variables we employ analytic methods to understand the economics of the nkpc identification problem in the canonical three equation new keynesian model we revisit the empirical evidence for the usa the uk and canada by constructing tests and confidence intervals based on the anderson and rubin 1949 statistic which is robust to weak identification we also apply the guggenberger and smith 2008 lm test to the underlying nkpc pricing parameters both tests yield little evidence of forward looking inflation dynamics copyright 2008 john wiley sons ltd

identification issues in forward looking models estimated by gmm with an application to the phillips curve limited information methods are commonly used to estimate forward looking models with rational expectations such as the new keynesian phillips curve of gal and gertler 1999 in this paper we address issues of identiflcation that have been overlooked due to the incompleteness of the single equation formulation we show that problems of weak instruments may arise depending on the properties of the exogenous variables and that they are empirically relevant we also uncover a link between identiflcation and dynamic mis speciflcation and examine the lack of power of hansen s 1982 j test to detect invalid over identifying restrictions with regards to the new phillips curve we flnd that problems of identiflcation cannot be ruled out and they deserve further attention

inflation dynamics and the parallel market for foreign exchange abstract pinto 1990 in world bank economic review 3 321 338 showed that unification of official and parallel market exchange rates may lead to an increase in steady state inflation because of the fiscal impact of real official exchange rate changes this paper shows how this and other comparative static and stability results in pinto 1990 are reversed under the assumption that official exchange rate devaluation reduces money creation in the economy it is argued that this was the case for uganda in the 1980s and we give a simple rule of thumb for estimating when unification will increase or decrease steady state inflation

local identification in dsge models abstract the issue of identification arises whenever structural models are estimated lack of identification means that the empirical implications of some model parameters are either undetectable or indistinguishable from the implications of other parameters therefore identifiability must be verified prior to estimation this paper provides a simple method for conducting local identification analysis in linearized dsge models estimated in both full and limited information settings in addition to establishing which parameters are locally identified and which are not researchers can determine whether the identification failures are due to data limitations such as lack of observations for some variables or whether they are intrinsic to the structure of the model the methodology is illustrated using a medium scale dsge model

the computational experiment an econometric tool an economic experiment consists of the act of placing people in an environment desired by the experimenter who then records the time paths of their economic behavior performing experiments that use actual people at the level of national economies is obviously not practical but constructing a model economy and computing the economic behavior of the model s people is such experiments are termed computational this essay specifies the steps in designing a computational experiment to address some well posed quantitative question the authors emphasize that the computational experiment is an econometric tool used in the task of deriving the quantitative implications of theory

fiscal regimes and fiscal sustainability in sri lanka this paper employs the regime switching model based fiscal sustainability test which relaxes the linear fiscal reaction function approach there is evidence of a regime switching fiscal rule in sri