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FISCAL & MONETARY: IT TAKES TWO TO TANGO

FISCAL & MONETARY: IT TAKES TWO TO TANGO. Robert TCHAIDZE, ISET For the NBG conference on monetary policy. The Main Messages. Coordination of fiscal and monetary is … … important; … even more so in a country like Georgia; … under any monetary regime; … in any macroeconomic circumstances.

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FISCAL & MONETARY: IT TAKES TWO TO TANGO

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  1. FISCAL & MONETARY: IT TAKES TWO TO TANGO Robert TCHAIDZE, ISET For the NBG conference on monetary policy

  2. The Main Messages • Coordination of fiscal and monetary is … • … important; • … even more so in a country like Georgia; • … under any monetary regime; • … in any macroeconomic circumstances. • NB: this presentation is not about the country of Georgia. It is about a country like Georgia. Robert Tchaidze: FISCAL & MONETARY

  3. Motivation and Theory • Simple macroeconomic models show that a policy measure by monetary can be undone or exaggerated by fiscal and vice versa. • Wrong moves do not need to be actually happening. Expectations that they may happen are enough to screw things up. Robert Tchaidze: FISCAL & MONETARY

  4. Motivation and Theory • This needs to be sufficiently appreciated. • Lack of coordination shows up in variables (inflation, interest rate, exchange rate) that are easier to attribute to monetary than fiscal. • Hence, very tempting to take actions driven by political agenda and place the blame with monetary. Robert Tchaidze: FISCAL & MONETARY

  5. What can go wrong: • Traditional story: • Spending → inflation; • Domestic borrowing → interest rates; • FX privatization/borrowing → exchange rates. • Less so: • Quasi-fiscal operations; • Functioning of T-bill/liquidity market. Robert Tchaidze: FISCAL & MONETARY

  6. Coordination • Macroeconomic management: • Level of deficit; • Domestic and foreign borrowing; • Composition of spending (current/capital). • Liquidity management: • Timing of spending, borrowing, payments, FX conversion; • Maintenance of T-bill market. Robert Tchaidze: FISCAL & MONETARY

  7. Coordination is important under any monetary regime • Fixed exchange rate regime (peg): • Persistent budget deficits drain reserves forcing CB to abandon the peg. • Currency board/dollarization/currency union: • Loose fiscal policy (excessive spending or low taxes) leads to real exchange rate appreciation. • Free float (either IT or Dual Target) : • Loose fiscal policy (excessive spending or low taxes) leads to inflation. Robert Tchaidze: FISCAL & MONETARY

  8. Structurally changing economies • I.e., transitional/developing economies, emerging markets where new rules, mechanisms, structures are being set up. • Often these are small open economies with their own currencies. • In such economies the issues become much more problematic than in developed economies. Robert Tchaidze: FISCAL & MONETARY

  9. Structurally changing economies • Potential of monetary is limited; • Scale of things is much bigger (massive inflows, total privatization, sweeping reforms); • Politics dominated by one party; party dominated by few individuals; • Business-politics connections tighter; • Public awareness is limited. Robert Tchaidze: FISCAL & MONETARY

  10. Examples • These are clearly economic decisions but they could to a larger than warranted degree be reflective of political considerations: • Social safety net spending; • Tax cuts; • Privatization; • Donor aid. • These are reasonable and warranted actions that may have very unpleasant consequences. Robert Tchaidze: FISCAL & MONETARY

  11. Iceland • Banks were a big part of the story but not the only one. • The other parts are reflective of politics and structural changes: • Investment into aluminum industry; • Tax cuts; • Housing fund. • Directly contributed to overheating. • Indirectly, as these helped establish an image of a dynamic transforming country, inducing foreigners to invest into it and Icelanders to spend. Robert Tchaidze: FISCAL & MONETARY

  12. Iceland • Consequences: • Exchange rate appreciation; • Inflation; • Asset (real estate and stock market) bubbles; • Huge current account deficit; • High level of household and external debt. • Very different views held by the Central Bank and Ministry of Finance staff. E.g. output gap estimates: +5 percent (CBI); +1 percent (MoF) • Budget surpluses of 5 percent of GDP, creating an impression of tight fiscal policy. Robert Tchaidze: FISCAL & MONETARY

  13. The Main Messages • Coordination of fiscal and monetary is … • … important; • … even more so in a country like Georgia; • … under any monetary regime; • … in any macroeconomic circumstances. • NB: this presentation is not about the country of Georgia. It is about a country like Georgia. Robert Tchaidze: FISCAL & MONETARY

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