Discussion of Policy Volatility, Institutions and Economic Growth By Antonio Fatás and Ilian Mihov

1. Discussion ofPolicy Volatility, Institutions and Economic GrowthBy Antonio Fatás and Ilian Mihov By Vicente Tuesta Central Bank of Perú March, 2006

2. Motivation • Institutions versus Discretionary Macroeconomic Policies • Standard view: good macroeconomic policies are the cause of increased stability. • AJRT (2003) Bad macroeconomic policies are just the symptoms of weak institutions (key instrument to shape current institutions…..mortality rate).

3. What do the authors do? • Re-evaluate whether macroeconomic policies matter for economic performance. • Evaluate causal effect from institutions to fiscal policy volatility

4. How? • They construct a measure that captures the exogenous component of fiscal stance.

5. What do they find? • Fiscal policy volatility affects growth negatively (a significant direct effect) Institutions are important to the extent that they shape policy outcomes (40%)

6. Comment I: Exogeneity of fiscal Stance • Sample of coutries: Developing economies have less room to be countercyclical, therefore larger volatility during crises. Larger volatility in developing countries, institutions might be less informative.... • Institution is a highly persistent state variable. • Growth is very disperse across countries as it is volatility. • Therefore: volatility of might be a good candidate to have an effect on growth. • What about the level of the shocks? Large errors are the driving forces!! • Reduced form estimation. Some general equilibrium story is needed.

7. Comment II: What else can explain fiscal policy volatility? • Institutions are just a part of it (for the whole sample of countries) • A country’s capacity to absorve other shocks (i.e. terms of trade shocks, foreign interest rate shocks)

8. Comment III: Non lineal effects • If discretionary fiscal policy is important, how much discretion is optimal? Which level of fiscal policy volatility is good? • Developed and developing countries must have different threholds of fiscal volatility.

9. Comment IV: Channels of transmission • Policy volatility: Investment • But, this is not the case for rich countries. • Puzzle, given the link between policy volatility and growth. • Risk-Sharing is easier in rich countries than in developing countries. • Financial integration might help developing countries.

10. Comment V: Another channel • Fiscal volatility is associated to demand shocks. • What about supply shocks? • Kydland and Prescott (1982): TFP explains great part of macro volatility • Technological adoption might be significantly linked to institutional variables (i.e. barriers such as legal constraints). I guess its omission is not neutral to the analysis.

11. Negative relationship Growth in Perú Macro Stability is needed

12. Fiscal Policy Primari deficit: less pro-cyclical and less volatile during

13. Before IT: Procyclical monetary policy Ahora: Countercylical Policy: Y   interest rates  Monetary Policy

14. Conclusion • A great contribution. It generates debate in the literature of economic growth • Very careful estimations. But a deeply theoretical understanding of the link between fiscal policy volatility and growth is needed.