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Fiscal Policy Options and their Macroeconomic Impact

Fiscal Policy Options and their Macroeconomic Impact. Jan Gottschalk (May 2010). Option I—Large Fiscal Expansion: 2010 Budget Amendment and MTBF 2011-13. The fiscal expansion would trigger another demand-led boom, on top of already strong demand conditions:.

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Fiscal Policy Options and their Macroeconomic Impact

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  1. Fiscal Policy Options and their Macroeconomic Impact Jan Gottschalk (May 2010)

  2. Option I—Large Fiscal Expansion: 2010 Budget Amendment and MTBF 2011-13

  3. The fiscal expansion would trigger another demand-led boom, on top of already strong demand conditions:

  4. The inflationary impact will be large, and together with current meat price inflation, will lead to high and persistent inflation:

  5. The financing of the fiscal expansion in the MTBF is much more risky than it was during the 2006-08 boom-bust cycle:

  6. The combination of high inflation and uncertain financing is risky: • Persistent, double-digit inflation is costly and erodes confidence in the currency • Simulations assume passive monetary policy stance that resists nominal currency appreciation and allows high inflation: even without a nominal appreciation, the currency will appreciate in real terms, which will hit the tradable sector hard • If the currency is allowed to appreciate in nominal terms, the increase in inflation would be much smaller, at the cost of a more immediate negative impact on the tradable sector

  7. If financing inflows stop, in the absence of an immediate fiscal tightening, a large currency depreciation is likely • In a high inflation environment, this could lead to a depreciation-inflation spiral and ultimately to a collapse of the currency (full dollarization) • This risk is less pronounced if the currency was allowed to appreciate initially, but macroeconomic volatility/turmoil will nevertheless be substantial

  8. Monetary policy has no good options: • Its best bet is to allow a nominal currency depreciation; the tradable sector will suffer, but the real appreciation is ultimately the result of the fiscal expansion and will take place either through the nominal appreciation or high inflation, • or monetary policy tightens dramatically to offset the inflationary impact of the fiscal expansion

  9. Drastic monetary tightening (increase in policy rate to at least 20% over next two years) is effective in controlling inflation, …

  10. … but at the cost of a massive recession and crowding out of the private sector:

  11. Option II: Combating inflationary pressures and financial risks through expenditure restraint

  12. The output gap would close …

  13. … and inflation would return to the low single digits:

  14. In nominal terms, expenditures under this option would be considerably smaller, …

  15. … but in real terms the difference is much smaller, because inflation erodes the purchasing power of expenditures under the MTBF scenario:

  16. Bottomline • The fiscal expansion planned in the MTBF carries substantial risks to macroeconomic stability, • with high inflation eroding the purchasing power of these expenditures, • such that in real terms, expenditures are not much higher than under an alternative scenario with expenditure restraint.

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