savings ratios alone is potentially misleading. The results also
illustrate the degree of endogeneity of budget deficits and national
savings. Differences in marginal tax rates, transfer payments and
national debt levels across countries imply significant differences in
the behavior of budget deficits as income, prices and interest rates vary
over the business cycle. It is also evident that savings behavior can
vary across countries, reflecting differences in the cyclical responses
of domestic expenditure, among other factors. These differences,
combined with the fact that countries rarely are perfectly in phase
cyclically, reinforce the view that ratios of current government deficits
to domestic savings may not be a very meaningful basis for comparing
exogenous credit market pressures imposed by different fiscal policies
across countries.

Having illustrated the empirical difficulties associated with
these ratios, what can be done to increase their usefulness? First, the
problem that endogeneity poses for international comparison might be
neutralized to some degree by adjusting the ratios for cyclical
fluctuations, as was suggested in the preceeding section. At a minimum,
tax receipts should be adjusted for cyclical differences across
countries, using potential GNP or some other cyclically-neutral income
measure. To be consistent, the denominator of the ratio, savings,
probebly should be adjusted for cyclical swings in income as well. In
addition, given the importance of debt service payments in government
budgets, it may be advisable to try to adjust for cyclical variation in
interest rates, although this would be more difficult (do we adjust for
transitory shifts in monetary policy as well as income?).

Finally, if an appropriate set of ratios could be computed


III-14

Table 3

Net Funds Raised by General Government as a Share of
Total Funds Raised by Non-Financial Sectors—

1975-1981
1975 1976 1977 1978 1979 1980 1981 Average
Canada 24.9 19.0 28.6 32.5 15.2 27.5 22.0 24.3
France 27.3 14.8 13.4 23.3 12.5 8.4 15.4 16.5
Germany 42.8 30.4 26.4 25.9 21.8 17.1 26.4 27.3
Italy 57.1 53.6 51.4 54.2 43.9 52.1 53.0 52.2
Japan 36.3 40.8 46.7 56.0 48.8 47.5 45.5 45.9
United Kingdom 46.3 26.2 37.7 19.2 28.0 23.2 10.3 27.3
United States 46.2 30.8 21.6 18.1 14.3 26.8 27.0 26.4

T7 The denominator of the ratio is net funds (i.e., gross borrowing less redemptions) raised
on credit markets by total non-financial domestic sectors plus rest of world. For Japan
the denominator excludes the rest of the world.

Source: OECD, Financial Accounts.


II-1

*
Il. Deficit Savings Ratios--A Quantitative Assessment

This section provides a quantitative analysis of ratios of
government deficits to domestic savings, as indicators of the pressure of
public sector borrowing on domestic credit markets. As outlined in the
preceding section, the usefulness of these indicators, particularly for
making comparisons across countries, can be limited in two respects. The
first concerns the extent to which identical exogenous shocks to deficit-
savings ratios differ across countries with respect to their impacts on
domestic interest rates, income and prices. That is, do similar values
of ratios imply similar degrees of credit-market pressure across
countries? The second concerns the extent to which deficit-savings
ratios are influenced by other variables and the extent to which such
influences differ across countries. If the ratios are significantly
affected by variables other than discretionary government spending and
financing decisions, they could be misleading indicators of comparative
exogenous credit market pressures across countries.

Our quantitative analysis of these issues is based on
simulations with the Federal Reserve Board staff's Multicountry Model
(MCM). The simulation results suggest both that the effects of similar
exogenous shocks to government deficits differ significantly across
countries and that deficit-savings ratios are substantially affected by
other variables. Of course, these results are conditional upon the

particular structure and parameters of the model employed./

*/ This section was drafted by Peter Hooper. Steve Symansky, Ralph
Tryon, Joerg Dittmer and Caryl McNeilly contibuted to the simulation
results reported here.

i/ ‘The MCM is described in detail in Guy V. G. Stevens, et. al. The
U.S. Economy in an Interdependent World: A Multicountry Model,
Federal Reserve Board, Washington D.C., 1983. The current version of
the model is presented in "FRB Multicountry Model," Quantitative
Studies Section, Division of International Finance, Federal Reserve



III-1

*
Il. Indicators of Credit Market Pressure--Data Accounting Isues.

In this section we concentrate on questions concerning those
observable variables and ratios which might be used to represent savings
drain or credit market pressure. The wider question, whether any ratio
of enclogenous variables, defined for an individual country in an
international economy, and not cyclically-corrected, can serve as an
exogerious indicator of pressure was considered in the preceding sections.

The framework we use derives from the UN System of National
Accourts (SNA). In the SNA, the major sectors of the economy --
government, households, corporations and rest of world -- have a

y/

consistent set of accounts. In particular, the government's

transactions are -- like the others -- divided into a current account and
a capital account .2/ This treatment differs from the U.S. National
Income and Product Accounts which treats all public expenditures,
including capital formation, as current expenditures. In the SNA the
difference between current expenditures and revenues constitutes the
Saving (or dis-saving) of the government. Saving balances are also drawn
for the other sectors of the economy. The SNA then draws another
balance, taking account of "receipts" (mainly capital consumption

allowances) and expenditures (primarily capital formation). The balance

on current and capital accounts is then net lending or net borrowing of

*/ This section was drafted by Raymond Lubitz.

1/ Throughout this section we use the terms "public sector" and
government interchangeably. The public sector often refers to
government plus public enterprises. The former term refers primarily
to non-marketable activities, and this is what is meant in the body
of the section. In an appendix to this section we discuss some
issues concerning the more-broadly-defined public sector.

2/ The OECD Occasional Study Public Sector Budget Balances (OECD, Paris,
1976) explains some of the SNA concepts, focusing in particular on
the public sector accounts.



I-2

rates as the equivalent increase in any foreign government deficit.
However, before turning to these two cases, we shall review briefly
reasons for standardizing our deficit and saving calculations at some
point of the business cycle.

Consider an exogenous increase in government spending (or decrease
in taxes). It might seem that such an increase in the deficit would lead
both to a rise in the ratio of the government deficit to savings (D/S)
and to higher interest rates. If it did, one might be tempted to infer
that a rise in the deficit/savings ratio indicates upward pressure on
interest rates resulting from expansionary fiscal policy. There are at
least two reasons to exercise caution in making such an inference.

First, as shown below, an exogenous increase in government spendirg may
lead to a fall rather than a rise in the deficit/savings ratio. Second,
a more expansionary fiscal policy is not the sole exogenous change that
is consistent with increases in both interest rates and the
deficit/savings ratio.

An exogenous fiscal stimulus increases income and the interest rate
but may raise or lower the deficit/savings ratio. Note that in a closed
economy the deficit/savings ratio can be rewritten as one minus the
investment/savings ratio (I/S):

(1) b/s = (8 - 1)/S = 1 - 1/s.2/

D/S rises if I/S falls following a fiscal stimulus. The increase in
income raises savings, and the rise in interest rates lowers investment
1/ Note that here we are defining S as private saving rather than

national saving as in section's II and III. The argument of this
section holds regardless of the savings variable employed.


III-12

Table 1

General Government Saving and Net National Saving2/
(Percent of GDP)

1975-1981
1975 1976 1977 1978 1979 1980 1981 _ Average 2/

Canada

Government Saving 0.1 0.4 (0.4) (1.3) (0.3) (0.5) 0.3 (0.3)

National Saving 10.1 10.9 10.0 9.1 11.0 10.7 10.4 10.1

Ratio 0.7 3.5 (4.2) (14.8) (3.1) (4.9) 2,4 (2.9)
France

Government Saving 1.1 2.8 1.6 0.3 1.4 2.5 0.4 1.5

National Saving 12.1 11.2 11.5 11.4 11.6 10.4 7.6 10.8

Ratio 8.9 25.0 14.2 2.2 12.4 24.1 5.5 13.2
Germany

Government Saving (0.7) 1.4 2.3 2.0 2.0 1.8 0.3 1.3

National Saving 9.5 11.1 10.8 11.7 11.8 10.4 8.6 10.6

Ratio (7.3) 12.2 21.5 17.3 16.9 17.1 4.0 11.7
Italy

Government Saving (7.1) (5.1) (4.3) (5.7) (5.4) (4.0) (7.4) (5.6)

National Saving 9.8 12.1 12.3 12.3 13.2 13.0 8.7 11.6

Ratio (72.5) (42.4) (34.6) (46.1) (40.6) (30.9) (86.0) (50.4)
Japan

Government Saving 3.2 2.0 2.3 1.4 2.4 2.6 2.8 2.4

National Saving 19.2 19.8 18.9 19.2 18.4 18.5 17.7 18.8

Ratio 16.5 10.0 12.0 7.2 13.1 14.0 15.6 12.6
United Kingdom

Government Saving (0.3) (1.0) (0.3) (1.6) (1.0) (1.4) (1.3) (1.0)

National Saving 5.1 5.6 8.6 8.8 8.9 6.8 4.9 7.0

Ratio (5.1) (17.6) (3.5) (18.6) (11.3) (19.9) (25.7) (14.5)
United States

Government Saving (3.1) (1.6) (0.4) 0.7 1.2 (0.7) (0.5) (0.6)

National Saving 5.1 5.7 6.9 8.0 7.6 5.0 5.6 6.3

Ratio (60.3) (27.0) (5.6) 9.2 15.1 (13.3) (9.1) (13.0)

1/  Dissaving is shown by use of parentheses.
2/ | The ratio is the average of the annual ratios.

Source: ECD, National Accounts.


along these lines, the simulation results discussed above may provide
some guidance to a more meaningful interpretation of those ratios. Based
on the models we have considered, an exogenous shift in the deficit-
savings ratio appears to exert greater pressure on domestic credit
markets--as measured by increased interest rates--in the United States
than in at least three other major industrial countries. Also, "crowding
out" appears to have a more detrimental impact on real growth in the
United States than in other countries. However, the cost in terms of

increased inflation appears to be somewhat lower in the United States.


III-4

financial sectors. And, of course, it is an endogenous ratio and carnot
be taken as an exogenous measure of credit market pressure.

Another drawback of these measures is that they simply look at
credit market funds. Other outlets for the investment of financial
assets, which are substitutable in portfolios for securities, are not.
included. One might be tempted to use the total change in financial
assets as the denominator in the ratio for government borrowing; however,
this would involve double-counting of the claims and liabilities of
financial intermediaries.

Two other aspects of the comparisons should be raised. The
first concerns the scope of government. Although much of the public
discussion focuses on central government deficits, we think that there is
a strong case for using general government as the basis of comparison.
The central government budget is often used presumably because it is the
focus of fiscal policy and because data are more readily available.
However, countries differ on the location and financing of government:
activities among different levels of government; consequently, in order
to compare government activity it is artificial to look at central
government alone. Moreover, within a country, the financing of a given
government function can shift between central and local governments.
While the general government balance may be unaltered by this shift, the
central government balance would change._/

A second question concerns gross versus net saving. Ideally,

(at least from the standpoint of economic growth theory) net saving and

7/ In the IMF's World Economic Outlook (Occasional Paper 9, 1982) the
limitations of the central government balance are explained at
somewhat qreater length than here. (p. 105) Despite this, the
comparisons using the central government seem to be given preference
in the IMF presentation.



II-10
Table 2

Simulated Impacts of Exogenous Government Spending Increases on
Government Neficits and Gross National Savings

(All results except those for deficit-savings ratios are expressed as
percentages of nominal GNP.)

Numbers of Quarters Following Shock

o f 8 i 16
U.S.
Government Spending (Exog.) 9 9 9 9 9
" "Total 9 9 9 a) 1.0
Transfers 0 0 0 a 0
Interest Payments 0 0 (0) 0 0
Taxes 2 3 3 3 2
Government Deficit 6 7 8 ) 1.3
Gross National Savings al -.3 -.3 0.3 0.3
Deficit-Savings Ratio (%) 3.0 3.6 4.1 4.5 6.6
Germany
Government Spending (Exog.) 1.2 1.2 1.2 1.2 1.2
" " Total 1.2 1.3 1.3 1.4 1.6
Transfers al -.04  -.1 ll 4
Taxes 7 9 1.3 1.9 2.3
Government Deficit 7 3 0.1 -.3 -.3
Gross National Savings -.5 -.2 2 5 5
Deficit-Savings Ratio (%) 3.6 1.5 -.5 -1.5 -1.5
Canada
Government Spending (Exog.) 1.0 1.0 1.0 1.0 1.0
" " Total 1.0 1.1 1.2 1.2 1.2
Transfers al 2 2 3 2
Taxes 3 4 5 5 4
Government Deficit 8 8 9 a) 1.0
Gross National Savings -.2 -.4 -.4 -.5 -.7
Deficit-Savings Ratio (4%) 4.0 4.1 4.6 4.6 5.2
U.K.
Government Spending (Exog.) 1.1 1.1 1.1 1.1 1.1
" "~ Total 1.1 1.1 1.0 1.0 1.0
Transfers 2 3 3 6 8
Taxes 2 al al 4 4
Government Deficit 1.2 11 1.2 1.3 1.4
Gross National Savings -.01 -.4 -.6 -.5 -.3
Deficit-Savings Ratio (%) 6.0 5.6 6.2 6.7 7.3


III-13

Table 2

General Government Gross Saving (Nissaving) and Gross National Savingl/
(Percent of GNP)

1975-198}
1975 1976 1977 1978 1979 1980 1981 Average“!
Canada

Government Saving 1.6 1.8 1.1 0.2 1.2 1.0 1.8 1.3

National Saving 21.1 21.5 19.8 20.0 22.0 21.9 21.4 21.1

Ratio 7.5 8.6 5.6 1.0 5.4 4.7 8.6 5.9
France

Government Saving 2.0 3.8 2.7 1.3 2.5 3.7 1.6 2.5

National Saving 23.0 23.0 22.7 22.6 22.8 21.9 19.4 22.2

Ratio 8.9 16.5 11.7 5.7 11.1 16.7 8.3 11.3
Germany

Government Saving (0.1) 1.9 2.9 2.6 2.6 2.4 1.0 1.9

National Saving 20.8 22.2 21.8 22.8 23.0 22.1 20.8 21.9

Ratio (0.7) 8.6 13.2 11.4 11.2 10.9 4.8 8.5
Italy

Government Saving (6.8) (4.8) (4.0) (5.4) (5.1) (3.8) (7.2) (5.3)

National Saving 20.1 22.2 22.6 22.4 23.0 22.6 18.9 21.7

Ratio (33.7) (21.8) (17.8) (24.2) (22.1) (16.6) (38.0) (24.9)
Japan

Government Saving 3.6 2.5 2.8 1.9 3.0 3.2 3.5 2.9

National Saving 32.2 32.6 31.9 32.3 31.6 31.9 31.9 32.1

Ratio 11.2 7.5 8.6 5.9 9.4 10.0 10.9 9.1
United Kingdom

Government Saving 1.1 0.3 1.0 (0.4) 0.2 (0.1) 0.1 0.3

National Saving 15.8 16.4 19.6 20.2 20.4 18.9 17.3 18.4

Ratio 6.7 1.9 4.9 (2.1) 1.1 (0.2) 0.7 1.9
United States

Government Saving (1.5) (0.1) 1.1 2.2 2.7 0.9 1.0 0.9

National Saving 17.5 17.9 19.0 20.3 20.4 18.3 18.9 18.9

Ratio (8.5) (0.3) 5.6 10.8 13.2 5.0 5.4 4.5

I/ Dissaving is shown by use of parentheses.
2/ The ratio is the average of the annual ratios.

Source: OECD, National Accounts.


(which rise with interest rates and the budget deficit), transfer
Payments (which rise as output and employment falls) and the effects of
inflation on government spending. In Table 2, interest payments are
included with transfer payments in all cases except the U.S. results.
Also, the effects of inflation on government spending are measured as the
difference between "Total" and "Exogenous" government spending. This
difference is noticeable for Germany and Canada, where the fiscal shocks
had a significant impact on domestic prices.

Significant differences between the exogenous spending shock
and the government deficit arise in the U.S. and German simulations. In
the !J.S. case, the rise in the deficit initially falls short of the
exogenous spending increase due to an increase in tax receipts. After
four years, however, with the rise in interest rates and decline in GNP,
interest and transfer payments exceed tax receipts and the deficit rises
well above the inital exogenous spending shock. In the German case, the
change in the deficit never reaches the level of the spending shock, as a
large increase in tax receipts more than offsets increased spending and
transfers. In fact, within two years the initial deficit becomes a small
surpius. This result reflects two factors: 1) a high aggregate marginal
tax rate in the German model (about 0.5 of nominal GNP) and 2) a
substantial increase in German nominal income, as discussed above. In
the Canadian and U.K. - cases, changes in endogenous components of the
budget about offset one another, and the deficit does not differ greatly
from the initial shock.

The change in gross national savings is equal to the change in
private savings (as defined by disposable income minus consumption) plus

government savings (as defined by the government-budget surplus, or minus


I-7

If kon is constant across countries, then Den/Seq is an indicator
of the interest rate pressure generated hy exogenous changes in fiscal
policy that is appropriate for cross-country comparisons. Kon will be
constant across countries if (1) the income elasticities of money demand,
savings, investment, government spending, and taxes, (2) the interest
rate semi-elasticities of money demand, savings and investment, and (3)
the ratios of investment, taxes and government spending to cyclically
adjusted savings are the same across countries. Some readers will see no
reason for these parameters to be identical across countries, while
others will expect, a priori, no differences. Of course, Ken could be
constant across countries if, by chance, the inter-country differences in

the parameters just listed were exactly offsetting.

IB. The Two-Country, Perfect Substitutes Case

Now consider the case in which the world is composed of a set of
countries which may be quite different but whose financial markets are
closely linked. In particular, suppose that each country in a two-
country world produces its own specialized output and that the
imperfectly substitutable goods are traded internationally. Residents of
each country hold the money of their country but not foreign money.
Securities denominated in the two currencies are perfect substitutes and
exchange rate expectations are static, so there is, in effect, one world
interest rate o/ Exchange rates are flexible. There is exogenous

government spending in both countries but no endogenous government

6/ All that is really required for our result is that expected rates
of change in exchange rates he independent of any current or expected
future variables.


III-10

The United States has the lowest ratio of public enterprise
borrowing as a share of GDP for the five countries shown; this, of
course, makes the United States look "better" in the total public sector
comparison.

One should not push such comparisons too far for several
reasons. First, definitions of public enterprises across countries
differ. Second, the range of activities covered by public enterprises
differs widely among countries so that differences in public enterprises'
borrowing reflect to some extent different national divisions of economic
functions between public and private enterprises. Third, public
enterprise borrowing may, from an economic point of view, be the same as
any private enterprise's borrowing, and should not therefore be viewed on
the same footing as general government's borrowing. However, public
enterprises do borrow from government, or receive government guarantees,
so that they are not always economic actors in the marketplace in the
same way that private enterprises are. Also, public enterprises may base
their investment, pricing and employment decisions on "social" criteria
and not simply follow strict market criteria. To the extent that they do
so, and incur greater losses or make smaller profits as a result of these
"social" decisions, then their borrowing is indeed a function of pursuing
social objectives as in the case of general government. To that extent
it is legitimate to add public enterprise borrowing to general goverrment
borrowing since they both are the consequences of political/social
activities of the public sector, and it is not the same as a private
enterprise raising funds for investment purposes. Of course, it is
impossible to make this distinction concerning the cause of public

enterprise borrowing in the statistics, and it is perhaps wisest to stick


IlI-7

offsets public dis-saving. Although the extreme version need not be
accepted, some offset may exist: if private saving does vary inversely
with public saving, we cannot assume that the public deficit absorbs some
fixed amount of private saving. Thus, national saving would be the more
appropriate variable with which to compare public saving. It is of
interest to note that the calculations of Blades and Sturm show that the
coefficient of variation across countries of national saving ratios is
lower than that of household ratios, for comparably defined savings
concepts, suggesting some offset .2/

Turning to the tables, since government saving may be either
positive or negative -- i.e., either add to or subtract from private
sector -- the ratio of government saving/GDP to national saving/GDP is
ambiguous. We have adopted the convention of placing parentheses around
negat‘ve net government saving and negative ratios. Tables 1 and 2 show
that for the 1975-80 period that the U.S. ranked high in terms of
government dis-saving -- or low in terms of government gross saving.

Table 3 shows borrowing by general government (corresponding to
the PSBR or net indebtedness), expressed as a percentage of credit market
borrowing by all non-financial sectors. The table indicates that the
United States is below the average for the other countries for the 1975-
80 period. It is also of interest to note the very high Japanese
borrowing ratios, despite the strong government saving performance. This
disparity (if it is such) may reflect the large amount of capital

formazion undertaken by the public sector in Japan -- so that while

9/ See Derek Blades and Peter Sturm, "The Concept and Measurement of
~ Saving: The United States and Other Industrialized Countries" in
Faderal Reserve Bank of Boston, Saving and Government Policy,

Conference Series No. 25, October 1982.



1-4

adjust the savings variable-- a theoretically easy but empirically
slippery task. It should be noted that we could evaluate each variable
at any level of income. If the economy in question is not in the
neighborhood of full employment, some other income level might be more

appropriate.

A, The Closed Economy Case

To begin with we consider the case in which the world is composed
of a collection of closed economies that differ only with respect to size
as measured by income and the average propensity to save, A conventional
model of a closed economy is given by:

(3) UY, r) +99 - g¥ - ty - tY - SLY - ty - tY, r] = 0,
(4) L(Y, nr) - M = 0,

The actual government deficit is given by
(5) D=g)- gY - ty - tY,
and the cyclically adjusted deficit is given by
(6) Poy = 99 - S¥cq - to - t¥cas

The change in the cyclically adjusted deficit,

7) ah. = ag - Y. ag - at. - Y_ at
(7) AP eg = 89g ~ Vogad ~ Bby - Vogtts


1-3

and may raise savings. However, if investment responds positively enough
to chariges in income, I/S might rise and D/S would then decline. Note
that the larger the marginal tax rate, the more likely it is that I/S
will rise because the larger the marginal tax rate, the smaller the
effect of the increase in income on savings 2!
Exogenous shocks other than expansionary fiscal policy can also
lead to increases in both the interest rate and the deficit/savings
ratio. Consider an exogenous decrease in the money supply which lowers

income and raises the interest rate. In a closed economy, the

deficit/savings ratio can be rewritten as:
(2) D/S = D/(I + D).

The decline in income as a result of contractionary monetary policy
raises the deficit and lowers investment. Investment spending also
declines with the increase in interest rates. Therefore, as long as
investment spending is positive, the percentage increase in the numerator
(D) exceeds the percentage increase in the denominator (I + D) which may,
of course, actually fall, so that the deficit/savings ratio must rise.

The above drawbacks to the use of changes in the deficit/savings
ratio as an indicator of interest rate pressure attributable to
variations in fiscal policy stem from the endogeneity of both the
numerator and the denominator (D and S$). The traditional way of avoiding
this problem is to look at the change in the full employment, or

cyclically adjusted, deficit. We shall follow this practice; we also

2/ In section II it is pointed out that an exogenous increase in

~ government spending leads to a fall in D/S in the German sector of
the Multi-Country Model. In the German sector, investment is highly
income elastic and the tax rate is high (0.5).


5/

the budget deficit). By manipulation of the GNP identity, this is also

equal to the change in gross private investment plus net exports .£/
Private savings rise with nominal income in each of the country
simulations. In most cases, the rise in private savings is less than the
decline in government savings, so that national savings fall and the
deficit-savings ratio rises. In the German case, however, the deficit-
savings ratio falls, as national savings rise and the government deficit
declines. The rise in national savings in the German case reflects,
among other factors, a relatively strong accelerator effect of GNP growth
on investment and the stimulus to net exports of a relatively large
depreciation of the mark.

The deficit-savings ratio numbers reported in Table 2 were
calculated under the assumptions that government budgets initially were
in balance, and that gross national savings initially amounted to 1/5 of
GNP in each country. Thus, an exogenous shock to government spending
(and the deficit) equal to 1 percent of GNP, or 5 percent of gross
savings, moves the ratio from zero to +5 percent on impact. One
indication of the endogeneity of the ratio is the degree to which the
impacts reported in Table 2 differ from +5 percent.

In brief, the simulation results presented here illustrate that
the responses of interest rates, income and prices to fiscal shocks can
differ substantially across countries. The behavioral and institutional
factors underlying these differences suggest that analysis of relative

credit market pressures based on international comparisons of deficit-

5/ As discussed in Section III, some preference might be given to gross
national savings as the denominator for the deficit savings ratio.

6/ Government investment is treated as current government spending in
the data shown in Table 2.


1-6

4/

where—

= ny/B,

B= e, E(I/S)nyy - (6/S)ngy - (T/S)nzy - ney
= mE S)eqp = espe

We can also write

(12) Arca = koal 40 ca/Scq)>

where

ca “Ly/Bca
ca = Eryl(1/Scq) ny - (8/Scq) gy ~ (T/Scq) "ry

~ (S/Soq)ngyd = ny yl(1/Scq)eqy ~ (S/Scq) egy

5/

Clearly, Ar + Aroq as Y + Yon since S + Seq + The closer the economy is

to cyclically adjusted’ output, the better is Aroq aS an approximation to

ar.

4/ sy = ngydnvdY. ns represents the elasticity of i with respect to
j’and €4j represent the semi-elasticity of i with respect to j.

5/ Note that if in equations (3) and (4) we start out away from full
employment, gg or tg will have to be adjusted in order to consider

a fiscal policy experiment in the neighborhood of cyclically adjusted
output.


III-2

the public sector. (Equivalent balances are also drawn for the other

sectors. )=/ Net lending corresponds to the "budget balance." When SNA

data are used, it is the concept that is typically used to compare public
sector balances and savings. However, in the SNA framework, such
comparisons of budget balances and savings compare conceptually different
balances -- the saving balance for the economy as a whole with the net
lending (or borrowing) of the public sector. In the U.S. NIPA, since
there is no distinction between current and capital accounts for the
public sector, the budget-balance national-saving comparison is more
reasonable.“/ Of course, even within the SNA framework, one might look
at public-sector net lending/national saving to show what the government
leaves for private sector investment, and this is what such comparisons
presumably intend. But since public capital formation is also taking
place, one cannot infer that the difference between national saving and
government net borrowing is what is available for capital formation ‘or
the nation as a whole.

On the basis of this discussion, our view is that the
comparison of budget balances and saving is less preferable than the
comparison between government saving (or dis-saving), i.e., the current
balance, and national saving. It is more appropriate for questions
concerning the "drain" on savings (or addition to savings) of the
government.

3/ Thus the household sector, in addition to its net saving (or dis~-
saving), which is the change in its net worth, may also borrow to
acquire capital goods. These transactions, in its capital account,
do not affect its net saving, but do affect its net lending (or
borrowing).

4/ It should be noted that the U.S. budget also does not include capital

account "receipts" so that the budget deficit on the U.S. NIPA basis
differs from the SNA.


International Finance Discussion Papers
Number 234

December 1983

DEFICIT-SAVINGS RATIOS AS INDICATORS OF INTEREST-RATE PRESSURE:
A COLLECTION OF NOTES

by

Gerard Caprio, Dale W. Henderson, Peter Hooper, Raymond Lubitz
and Steven A. Symansky

Note: International Finance Niscussion Capers are preliminary materials
circulated to stimulate discussion and critical comment. References in
publications to International Finance Discussion Papers (other than an
acknowledgement by a writer that he has had access to unpublished
material) should be cleared with the author or authors.


where

It must be assumed that C > 0 in order to obtain conventional results for
the effects of familiar disturbances.

In this model, then, an increase in the cyclically adjusted
government deficit in either country has the same effect on the world
interest rate. Stated alternatively, $1 of extra spending by the United
States government would exert the same interest rate pressure as the
equivalent increase in spending by any foreign government under the
assumption that assets are perfect substitutes. This result is intuitive
in a 1-good model or in a 2-good model in which the fraction of revenue
spent. by each government on each good is identical. In our model, one
might. suppose that increased government spending in country 1 would raise
Y by more than increased government spending abroad. However, with
freely floating exchange rates, it is readily verified that AY/ AD oq =
AY/ Ailey and that A/c, = A¥/ a3 cy because the exchange rate changes to
eliminate excess demands. In other words, if government spending rose at
home and declined abroad by an equal amount, there would be no change in
either country's income, The exchange rate, which, in our model, does
not directly affect other markets, is free to vary so as to eliminate the

excess demand at home and the excess supply abroad. Since either fiscal

* *
policy change (Mog or Deg) has the same impact on Y (or on Y), it


1-8
spending or exogenous or endogenous taxes /
Given the above assumptions, the equilibrium conditions of the model

8/

are—

(13) (Y, r)

+
"
°

dp - (Yr) + 2(Y, Ye)

(1a) 1, nr) +8) - 8) - ay, Ye)

a
°

(15) L(Y, r) -M = 0

=*
"
°

(16) L(¥, r) -

Foreign variables are indicated with asterisks. Since securities are
*
perfect substitutes r =r. Given our assumption regarding fiscal policy

- * _ * 9/
Deg = A9q and Den = AGg-—

In this case the change in the world interest rate is proportional
to the sum of the changes in the cyclically adjusted government deficits

of all countries, i.e.,
- *
(17) ar = q(ADeg + ADeq)»

7/ This last assumption is made for simplicity and does not affect our
results.

8/ This model is the same as the one used by Mundell (International Economics,
Chapter 18, Appendix) except that here investment is income sensitive and
savings are sensitive to interest rate changes.

9/ In other words, the change in the cyclically adjusted deficit is
equal to the exogenous change in the deficit.


III-9

Appendix: Public Enterprises Borrowing

The discussion in the text has been in terms of general
government which in the SNA essentially covers those activities of
government that provide non-marketed services (agencies providing small
amounts of marketable services may also be included in general
government). But the "public sector" encompasses more than this since
marketable services are provided by various types of government entities
-- departments, public corporations, nationalized industries. The SNA
envisages the collection of data for the “public sector" -- general
government plus government enterprises. The OECD Secretariat has
assembled and estimated data from various sources on government
enterprises 2/ They do not claim completeness or full comparability for
the series they constructed. However, the work is interesting and
relevant for the issues raised in this note. We show below net lending
as a share of GNP for both public enterprises and public sector (public
enterprises plus general government) for 1975-78 for the available major

countries.

Net Borrowing as a Share of GDP

(1975-78)
Public Enterprises Public Sector
Canada 3.1 5.8
France2/ 1.2 2.5
Japan 3.4 7.5
United Kingdom 1.4 5.8
United States 0.6 1.8

af 1975-77.

11/ They originally appeared in Definition and Measurement of the Public
Sactor (unpublished, OECD, April 1981); this work will appear in a
revised form in the Review of Income and Wealth.



III-8

government saving is high, borrowing is also high to help finance the
high capital formation.

As a final comment on these tables, and the issue of the
endogeneity of all the ratios presented here, one might tentatively put
forth the view that a 5 or 6 year average does allow some of the
endogeneity to wash out for purposes of international comparisons. And
for individual countries a given year's ratio compared to a longer-period
average may also be of some use. However, the limited usefulness of the
ratios, even averaged over a period of years, should be kept in mind.
These averages do not represent equilibrium positions with which
individual year's movements can be compared, and the cause of the
individual year's movements must still be known 20/

International comparisons for longer-period averages do have:
some significance for the savings drain argument. But this issue should
be put in a wider context. The rate of saving and investment in a
country, on economic welfare considerations, should be partly a function
of existing capital/labor and capital/output ratios. If the United
States has a higher level of capital intensity than the other major
industrial countries, its relatively low saving ratio is to that extent
justified. One might illustrate this point with the conclusion of the FR

study, Public Policy and Capital Formation, that the U.S. saving leve’ is

close to optimal -- although the composition of investment is not.

10/ In recent unpublished work hy the MECN Secretariat, full employment
savings and budget balances are compared. As our theoretical
discussion indicates, this is the direction such work should go,
although there are difficult estimation problems in making the full
employment estimates. Our discussion here is limited to what actual
data may tell us.


I-5

is approximately equal to the exogenous part of the change in the actual

deficit,

(8) Dey = Ad - YAg - Aty - Yat

Since

(9) Dog - ADey = (Y - Yoq) 49 + (VY - Yon) ats

Dog > ADey as the terms (Y - Yon) 49 and (Y - Yon) at each approach

zero.

The effect of an exogenous increase in the deficit on the interest

rate is given by

(10) ar = (Ly/A) Dey»

3/

where—

A= L(y -g-t- Sy) - Ly(1. - S,)s
Expressing the right-hand side of (10) in terms of elasticities and semi-

elasticities, we have

(11) ar = k(aDey/S),

3/ Note that Sy = Syd(1 - t).



Table 1

Simulated Interest Rate, Income and Price Effects of Exogenous
Government Deficit Increase Equal to 5% of Gross National Savings

U.S.
Interest Rates ('00 Basis Pts.)
3-Mo. Treas. Bill Rate
L-T Govt. Bond Rate
AAA Corporate Bond Rate

GNP (%)
GNP Deflator

Germany
Interest Rates ('00 Basis Pts.)
Short Term
Long Term

GNP (%)
GNP Deflator (%)

Canada
Interest Rates ('00 Basis Pts.)
Short Term
Long Term

GNP (%)
GNP Deflator (%)

U.K.
Interest Rates ('00 Basis Pts.)
Short Term
Long Term

GNP (%)
GNP Deflator

oo
Je
wonn

ND

- Number of Quarters Following Shock

4 8 Bw 16
2.7 2.9 2.4 2.5
0.7 1.1 1.2 1.3
1.1 2.0 2.6 2.8
1.0 0.4 0.3 0.1
0.1 0.4 0.7 0.5
0.8 1.2 2.0 2.4
0.3 0.5 0.9 1.2
1.9 2.3 2.8 2.5
0.1 0.4 1.3 2.5
0.3 0.5 0.8 1.1
0.1 0.2 0.4 0.6
1.1 1.0 0.9 0.7
0.3 0.7 1.1 1.4
0.4 -0.1 0.4 0.5
0.4 0.6 1.2 1.5
1.0 1.3 1.3 1.1
-0.4 -0.9 -0.4 -0.1


III-5

capital accumulation are preferable to gross measures. However, the
statistical and theoretical problems in calculating capital consumption
make net savings statistics less reliable than gross.

It might be noted that the ratio of capital consumption

allowances to gross savings varies widely across countries:

Capital Consumption Allowances/Gross Saving (SNA)

(1975 - 1981)

Canada 52.0
France 51.4
Germany 52.0
Italy 46.7
Japan 41.3
U.K. 62.6
US. 67.0

The United States has the highest ratio. To some extent this
probably reflects a higher U.S. capital-output ratio and therefore higher
ratio of depreciation to GNP. But the high level of British depreciation
(where one would not expect a high capital-output ratio) suggests this is
not the whole story. Other real factors -- age distribution of the
capital stock, lifetime of capital equipment, rate of obsolescence -- may
also play a role. It is reasonable to think that the data also reflect
diffaring tax treatment of depreciation as well as different procedures
followed by the national accounts statisticians in different countries in

estimating depreciation. In justifying the use of gross rather than net

ratios, one might also note that while capital accumulation reflects net


I-1

*
I, Incicators of Interest Rate Pressure--Theoretical Issues

4s noted in the introduction, there has been a search for simple
indicators of the interest rate pressure generated by changes in fiscal
policies. This effort has been motivated in part by the desire to make
comparisons, either through time or across countries, of the credit
market consequences of different fiscal policies. However, the case for
any such indicator must be based on a quite stringent set of explicit or
implicit assumptions. We show that a different indicator of interest
rate pressure would be appropriate for comparison across countries under
each of two alternative sets of explicit assumptions. Under the first
set of assumptions, the world is viewed as a collection of closed
economies that are identical in most respects. The countries may be of
different size as measured by income and may have different average
propensities to save. In this world an appropriate indicator of the
pressure generated by a change in any country's fiscal policy on its
interest rate is the ratio of the change in that country's cyclically
adjusted government deficit to cyclically adjusted savings.

Under the second set of assumptions, the world is viewed as a set
of not necessarily similar countries whose financial markets are closely
linked. In this world of perfect capital mobility and perfectly
substitutable assets, an appropriate indicator of the pressure generated
by a change in any country's fiscal policy on the single world interest
rate is simply the change in its cyclically adjusted budget deficit. In
other words, under this second set of assumptions, a $1 increase in the

U.S. gcvernment deficit generates the same pressure on world interest

*/ This section was drafted by Gerard Caprio, Dale Henderson,
and Steven Symansky.


After discussing the simulation results, we briefly consider
modifications to the ratios and their interpretation that would increase
their usefulness for interventional comparisons of this type.

To address these issues, simulations were run with the U.S.,
German, Canadian, and U.K. single-country sectors of the MCM. In each
country, the government budget deficit was shocked exogenously by an
amount equal to 5 percent of gross national savings (roughly 1 percent of
qpp) .2/ This was achieved by increasing government spending beginning in
198001, and holding the increment to spending constant in real terms over
a four-year simulation period through 198304. An effort was made to
standardize monetary policies in order to increase the comparability of
the results across countries. Each country was assumed to target on a
key monetary aggregate. In the U.S. and U.K. simulations Ml was held
unchanged from its historical and projected path. In the German case,
central bank money was used as the target variable, and in the Canadian
case the non-borrowed monetary base was used.2/

We consider first the simulated effects of the budget deficit
shocks on interest rates, income and prices in the four different
countries. These are shown in Table 1, at intervals of 1, 4, 8, 12 and
16 quarters following the imposition of the spending shock. The
qualitative results are fairly similar across countries and can be

summarized as follows. Increased government spending raises domestic

2/ The ratios of gross national savings to GDP are generally on the
order of 0.2, ranging from .19 for the U.S to .22 for Germany. See
Table (2) in Section III.

3/ The current structure of the Canadian model precluded us from using
Ml. The Japanese sector of the MCM was excluded from these
simulations because the existing financial structure of that model
was not set up to exogenize a monetary aggregate.


four years because the longer-run increase in nominal GNP, hence money
demand, is much greater in Germany than in the United States.

The longer-run impact on real income is substantially greater
in Germany than in the United States for three reasons: 1) the
estimated interest elasticities of consumption and investment
expenditures are much lower (in absolute terms) in Germany, 2) the
accelerator response of investment to income is substantially greater in
the German model and 3) the mark depreciation in the German simulat‘on is
2-3 times greater than the dollar depreciation in the U.S simulation,
with the resulting lagged stimulus to German real net exports
correspondingly larger. Prices rise more in Germany than in the United
States in longer run, due to the greater increase in aggregate demand,
the larger currency depreciation, and the greater openness of the German
economy. (Note that the domestic income and price effects of the
currency depreciations are slightly overstated in these single-country
simulations because foreign income and prices, which would be expectied to
move in an offsetting direction, have been held exogenous.)

Next we consider the endogeneity of the deficit-savings ratios
and differences in the behavior of those ratios across countries. ‘The
impacts of the exogenous government spending shocks on the government
deficit (including its major components) and on gross national savings
and deficit-savings ratios are given in Table 2. For purposes of
comparison across countries, these impacts have been expressed as
percentages of nominal GNP (except for the deficit-savings ratios, which
are expressed in percent terms).

The endogenous components of government deficits include tax

receipts (which rise with nominal income), government interest payments


-2-

The purpose of this collection of notes is to examine the
usefulness of such ratios as exogenous indicators of the interest rate or
credit market pressures generated by shifts in fiscal policies. Wa also
consider the extent to which such ratios provide a meaningful basis for
international comparisons. That is, does a ratio of a given size express
the same degree of credit market pressure across countries?

The first section provides a theoretical examination of the
appropriateness of different indicators of interest-rate pressure in the
polar alternatives of a closed economy and an open economy with perfect
substitutes. The second section provides an empirical analysis based on
simulations with the Federal Reserve Board staff's Multi-Country Model
(MCM); the results suggest that the effects of similar exogenous shocks
to government deficits differ significantly across countries and that
deficit savings ratios, far from being exogenous indicators, are
substantially affected by other variables. Notwithstanding the results
of sections 1 and 2, it is likely that the deficit-savings ratio will
continue to be used as an indicator of credit market pressure. Section 3
addresses the issue of the preferable measures of deficits and savings to

be used in such a comparison given the availability of data.


III-3

The question arises as to whether there is a more appropriate
denominator (other than saving) to compare to net lending (or borrowing)
of the government. Such a denominator is not apparent, because net
lending (or borrowing) of the country as a whole is simply the current
account balance.2/

In addition to the two balances already mentioned -- saving and
net lending -- a third government financial concept is also often used,
and refers to the government's total claim on the credit markets. OECD
statistics refers to this total as "net indebtedness," but in general
discussion abroad it is often known as the public sector borrowing
Tequirement (PSBR). It is the sum of the government's net lending (or
borrowing) plus the acquisition of financial assets. Thus, if the public
sector plays the role of financial intermediary -- both lending and
borrowing -- its net lending (or budget balance) position is unaffected,
but ‘its total borrowing requirement rises.

The PSBR may be compared to some concept of total credit
demands in the economy .o/ One deficiency of these ratios is that they

look at national credit markets in isolation. They do not deal with the

problem of including essentially intermediary activities of the non-

5/ Net lending (or borrowing) is -- in schematic terms -- the difference
between saving and investment (excluding transfers) for the private
sectors; for the public sector net lending is the budget balance.

For the economy (I-S) + (G-T) = current account. It might be added
that net lending of the private sector (S-I) also does not seem an
appropriate denominator for (G-T).

6/ lt might be argued that it is desirable to net intermediary
transactions out from the numerator and denominator of the
comparison, But this would return us to the net lending concept. It
cloes not seem appropriate to compare government net lending with
total credit -- since the latter (even excluding financial
intermediaries) -- does include transactions made by other sectors in
both lending and borrowing roles.


Deficit-Savings Ratios as Indicators of Interest-Rate Pressure:

A Collection of Notes”

Gerard Caprio, Dale W. Henderson, Peter Hooper, Raymond Lubitz

and Steven A. Symansky

A widespread concern in recent years has been the growth of
public sector deficits in industrial countries. Deficits have grown in
both a>solute terms and also expressed as a percentage of GNP. This
trend has provoked worries that the public sector's borrowing may exert
increasing pressure on credit markets, penalizing borrowing for private
investment, or put another way, that the public sector is absorbing
saving that would otherwise go for investment purposes.

As budget deficits grew within countries, with implications for
credit market conditions at home and in other countries, the need arose
to develop indicators suitable for international comparison. One such
indicator is the ratio of government deficits to GNP. The comparatively
low ratio for the United States has sometimes been taken as a reason to
downplay alarm expressed over the high level of U.S. deficits. However,
some observers have noted that comparisons of deficits to GNP's does not
adequazely capture the availability of resources in the private sectors
to offset the deficits. The preferred indicator of credit market
pressures induced by fiscal policy is one that relates deficits to

national or private savings.

*/ The authors wish to thank Edwin M. Truman for his encouragement in
the undertaking of this study. The views expressed here are the authors’
and do not necessarily represent the views of the Federal Reserve Board
or other members of its staff.


III-11

to the comparisons based on general government as in the text. However,
in interpreting the statistics in presentations such as Tables 1 and 2,
the omission of the public enterprises should be kept in mind. Since the
U.S. public enterprise borrowing ratio is the lowest for the available
major countries, if one assumes that the social/economic split on the
"causes" of this borrowing are similar across countries, then the total

U.S. public sector borrowing ratio is "improved" on a comparative basis.
Pp P:


III-6

investment, replacement investment is a carrier of new technology and
thus also contributes to economic growth. Although we show both net and
gross, the latter calculations are to be preferred.©/

Two sets of tables are attached. The first set compares
general government saving and national saving. In Table 1 government. net
saving and national net saving are shown as ratios of GDP; in Table 2 the
same ratios are shown for gross saving. These tables differ from the
more usual presentations in which public sector deficits are compared to
private savings rather than national savings. The rationale for making
the comparison with respect to private savings is that the public sector
deficit is seen as "draining" away resources from the private sector.
International comparisons on either basis will be the same, so that which
ratio is shown is not of great import. However, while much of the
discussion suggests that the public/private comparison is theoretically
the correct one, a contrary argument might be advanced. Some economists
have argued that private agents are more concerned with the total amount
of their saving, i.e., with national saving, whether privately or

publically performed, so that private saving will offset public dis-

saving. In extreme versions of this argument, private saving completely

8/ The IMF and OECD in presenting saving ratios generally focus on gross

~ ratios. The IMF staff in the World Economic Outlook appears to argue
that gross ratios are in principle preferable to net ratios (see pp.
105-6) because, among other reasons, they correspond to the finarcial
and investment flows that actually occur in the economy; firms do
not distinguish between net and replacement investment, and any such
national distinction does not match that between retained earnings
and capital consumption allowances. These arguments strengthen the
case that in practice gross flows are preferable to net; however, if
net data corresponding to theoretical concepts were available, they
would be preferable. The IMF approach is more appropriate to a
credit flows analysis than to a resources analysis where the concern
is the growth of the capital stock.



follows from (15) and (16) that either fiscal policy change has taken

some impact on the world interest rate. 10/

10/ It can be shown that AY/ADcq = AY/aBcq and that a¥/adc, = a¥/ all
that is, an increase in the cyclically adjusted governfant dericst 4 in
either country has the same effect on income in a given country.


M-3-
e

income and expenditures and the demand for money. Given fixed money
grow:h, short-term interest rates rise to equilibrate the money market.
Long-term interest rates generally rise more slowly, reflecting term-
structure relationships. (In the U.K. model the long-term rate is
directly affected by an increased supply of long-term government bonds to
finance the deficit.) The rise in interest rates depresses domestic
expenditures with a distributed lag, offsetting some of the initial
stimulus; it also causes an initial appreciation of the domestic
currency. The currency soon depreciates, however, as income growth
stimulates imports--the decline in the current account leads to a
depreciation through changes in expectations about the equilibrium real
exchange rate, given imperfect substitutability of assets in the long
run. The depreciation, in turn, stimulates net exports with a
distributed lag. Domestic wages and prices rise with a lag as the
increase in domestic expenditure puts upward pressure on labor demand and
capacity utilization, and as the currency depreciation raises import
prices, (A fall in prices in the U.K. case is due to the continuing
lagged effects of the initial appreciation of the pound, which are offset
only with a long lag by the subsequent depreciation.)

While there is some qualitative similarity across countries,
the quantitative impacts differ substantially. Interest rates rise much
faster in the United States than in other countries. This difference
reflects in large part a substantially lower (in absolute terms)
estimated interest elasticity of money demand in the United States than

in other countries 4/ German interest rates catch up to U.S. rates after

4/ The estimated interest elasticity of demand deposits in the MCM, U.S.
sector is about .08, compared with roughly .31 for Canada and .28 for
Germany.