Martín Redrado: Fiscal space for stability, growth and social inclusion
Remarks by Mr Martín Redrado, Governor of the Central Bank of Argentina, at the G-20
workshop, Buenos Aires, 19-20 June 2008.
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As many have mentioned, it could be a rarity to find a central banker addressing on fiscal
policy. But, as we have been discussing over the two days of this workshop, the growing
complexity of the world economy poses major challenges to policy makers. And, definitely,
the ability and flexibility to coordinate the different branches of economic policy lay as one of
the most significant.
It seems long ago when Keynes realized that there was more room for fiscal policy than just
being a public good provider. I believe it wasn't just a coincidence that it was him, being a
specialist in monetary issues, who came out with an answer to, probably, the most intriguing
problem of his time. His extraordinary comprehension about how the economy works planted
the seeds for the emergence of a macroeconomic theory, which we are still working out and
improving on a daily basis. In my opinion, we have a debt of honor to his legacy given the
long misinterpretation and wrong pursuing in economic policy on his word.
The analysis of public finance has many sides, some of which were addressed along this
workshop. From a theoretical standpoint, we can not state that a clear cut effect from fiscal
policy on growth. For instance, neoclassical growth models in the Solow's spirit account for
the government basically as a tax collector, showing that the impact on consumers' behavior
depends on savings pattern derived from the usual consumption optimization process. This
ultimately implies that fiscal policy can only determine the level of income, but can hardly
affect the pace of economic growth. These models have become an engine for the analysis
of fiscal policy and taxation.
In my view, these kinds of frameworks are robust in terms of describing some stylized facts
for free-market environments with very simplified hypothesis. However, they are not able to
address some empirical regularities, which are more usual in emerging countries. The vast
amount of unemployed resources, including the capacity of the public sector to take the first
step in solving this inefficiency is just one example.
On the other hand, endogenous growth models acknowledge that fiscal policy is one of the
key factors in explaining the different growth rates among countries. But according to this line
of thinking, as well as the classical models, a rise in public expenditure has no long-run effect
on the growth rate. The exception is the fact that they may increase private sector's yields
and, in that case, public investment could have positive effects on growth. This ultimately can
be seen as an improvement in productivity, and might help to understand why the fiscal
policy effect on growth seems to be underestimated, as Daniel Cohen pointed out on his
exposition.
But, as we are aware, models are set for very limited environments and the real world is
extremely complicated. Santiso made this point clearly.
I am not saying that we must forget about theory. Instead, i am suggesting that, in very
dynamic economies, we, policy makers, should relay as much on models as we do on good
judgment. The world is not linear, we have many discontinuities in the form of shocks from
many different sources. It would be too much to ask a model to be able to account for these
regular irregularities and, further, to be able to extract sound policy advice from it.
Another relevant issue on fiscal policy relates to the appropriate moment for implementation,
especially with regard to its implications for stability. In this respect, we need to identify better
ways to put together long-run objectives with short-run ones.
In the later case, we are more prone to recognize its role as a stabilizing force. However, the
ability of fiscal policy on reducing the volatility of the economic cycle is under deep scrutiny,
especially in the developed world. Probably this has to do with the usual handing over of the
stabilizing role to monetary policy. Also, the budgetary process seems to be too rigid to be
able to respond in a timely way.
In developing economies, usually more exposed to external shocks that hinder long-run fiscal
sustainability, the implementation of countercyclical policies seems to be more difficult.
Notwithstanding, there is mounting evidence on the relevance of fiscal policy as a stabilizing
economic force.
As we are witnessing today, when there are dual mandates and divergent paths, we, central
bankers, are confronted with an extremely challenging task that calls for coordination with
other economic policy instruments, that gives more room for fiscal action.
As an answer to the budgetary rigidities, there is a growing case for fiscal rules. Many
countries are putting in place this kind of framework as an institutional device to preserve the
countercyclical role of fiscal policy. We heard relevant experiences such the UK and Chile,
showing the applicability to both, industrial and emerging economies. But, we can not forget
the intervention from our colleges from Japan. They reminded us how disappointing this
could be and that there is no single recipe for every country.
Another striking issue for policy makers is the scope of public expenditure as a mean to
improve social inclusion and economic growth. We have seen the debate within the G-20,
evolving to these policy aspects. This morning the clear distinction between monetary and
fiscal policy was made, with the later, definitely, better suited to tackle micro problems.
In my opinion, this issue must be included on top of every single country agenda given that
income distribution is becoming not only a typical problem for developing countries but also,
more recently, for developed ones too.
As a central banker, the issue of policy interaction - largely debated on the economic
literature - is of great importance. One usual approach relates to the intertemporal debt
sustainability that calls for an aggregate budget constraint between fiscal surplus and
seigniorage revenue. This is a clear implication that macroeconomic management involves
both the treasury and the central bank. As a matter of fact, as Sargent and Wallace pointed
out back in 1981, the fiscal surplus must be large enough to pay out public debt services.
They framed it as a necessary condition for a consistent reduction in the rate of inflation over
time.
And this calls for another relevant relationship between fiscal and monetary policy, named
fiscal dominance. Fiscal dominance can arise in situations were public deficits and a
perception on government debt unsustainability hinders monetary policy credibility, even
when central banks have legal and de facto independence. In this regard we have the
theoretical framework first devised by Woodford that shows that is not enough to have a
monetary commitment to price stability to achieve it. Fiscal behavior must be clear in order to
evaluate the ability of the central bank to put in place its policy.
Pierpaolo Benigno also stressed the point when he was asked about the interaction of fiscal
and monetary policy over the business cycle. Speaking about inflation targeting, he stated
that a specific target on inflation might not be the best framework for countries with high fiscal
dominance or high nominal output volatility.
For instance, the eighties for Latin-American countries are acknowledged as a period of deep
fiscal dominance, which ended up in a collapse of many economies derived from
overspending and over-indebtness processes that in some cases led to hyper inflation
episodes.
Today the picture looks very different. Policy makers seem to be very aware of the costs of
overtaking money supply to fund public expenses. Recently, many emerging markets
reduced the fiscal stimulus as economic growth became more stable and resilient. Definitely,
what i call a "crowding-in" process. Several countries in Latin-America evolved towards the
recreation of budgetary institutions to encourage inter-temporal fiscal responsibility.
LatinAmerican governments have made notable efforts in the fiscal area to improve debt levels
and management as a mean to reduce vulnerability, with significant progress in recent years.
Pablo Guidotti also showed this yesterday.
As a result, financing needs are not an issue as it was in the past, even though shallow
capital markets all over the region act as a constraint for sustainable growth over the long
term. In fact, financial development is key - and will be even more so in our agenda.
The depth of the financial system and its integration with international capital markets has a
powerful disciplinary effect as it reduces incentives to follow expansionary policies as foreign
capital flow out to other markets with more predictable returns.
On the liability side, important progress has also been made in the region. The public debt to
GDP ratio decreased almost 30 percentage points over the last five years. This reflects, in
part, better liability management, which also shows up in the enormous reduction in the
exposure to foreign currency debt. The region is finally leaving behind the well-known original
sin that features last decades (currency mismatches), providing solid grounds for developing
domestic yield curve in local currency.
All over Latin America, financial systems are better-matched, well capitalized and less
exposed to public sector debt, another sin from the past. Not long ago, we used to have not
only central banks but also the financial system financing the treasury with no limits
whatsoever. In the case of Argentina, for instance, the policy designed by the central bank
aimed to this purpose led banks to reduce their government debt holdings that recently
stands at 14.6% of net assets, the lowest level in many years.
In my view, good economic analysis also imply not to bundle Latin American countries as
they follow very different patterns and are at different stages in their paths towards long-term
sustainability. Hasty diagnosis and simplistic comparisons among the various countries'
situations may lead to inappropriate policy recommendations.
To sum up, we have been through a period of better macroeconomic management all across
the world. We are witnessing the most turbulent times for the world economy in decades.
As I referred to early last year, when were heading towards a more volatile environment, the
resurgence of volatility is about to remain with us for a while. In such a context, emerging
economies are more resilient than in the past to confront external shocks.
And, while unusual conditions such as commodities price increases have played an
important role (as it was discussed this morning), more robust monetary policy and fiscal
strength are a key development behind this performance. On a longer-run, we must keep
working on rising human capital productivity by improving public education, investing on
social infrastructure all across the cycle, and adopting countercyclical measures to prevent
distributional effects in the downswings. Ultimately, this is the most important contribution
that we can deliver to our constituents.
As policy makers, we have to be careful about our assessment of current economic
environment. We must avoid a usual mistake which is to take that exceptionally good times
are about to remain forever, leading to policy relaxation. Here we are confronted with two
types of error: the first one is to take the good times as permanent ones, when it is really only
a temporary situation. The other possibility is to work as it is only a transitory good time but
the real underlying developments are about to be in place on a more permanent basis. As
policy makers we can not afford to fall in the first one. Thank you.