deficit-financed federal tax cut will not affect macroeconomic outcomes [Saxton (1999)]. effectiveness of monetary and fiscal policy over the period of financial crisis. Central banks indirectly target activity by influencing the money supply through adjustments to interest rates, bank reserve requirements, and the purchase and sale of government securities and foreign exchange. 86-136. Recent study, Doğan and Bilgili (2014) find that external borrowing has negative impact on growth both in regime at zero and regime at one, but the public debt has higher negative effects on economic growth and development, thus they conclude a non-linear relationship between economic development and borrowing variables. 529-554, available at: http://dx.doi.org/10.1016/j.jmoneco.2004.06.003. 53-70. Therefore, the rightful choice in this situation is institutional improvement and revolution. (Sims, 1992) argues that the counterintuitive price puzzle results can be blemished on methodological issues which arise from imperfectly controlling for some factors in the models. This fact suggests that we should consider the non-linear relationship between fiscal policy and economic growth in the emerging market economies. The turn in economics: neoclassical dominance to mainstream pluralism? Bi, H., Shen, W. and Yang, S.-C.S. 53-54. 44 No. (1995), Giavazzi et al. In taxes and expenditures, fiscal policy has for its field of action matters that are within government’s immediate control. (2005), “Fiscal deficits and inflation”, Journal of Monetary Economics, Vol. effectiveness of fiscal policy… Fiscal policy has been used as an antidote to weak activity during the most recent downturn and fiscal consolidation has been delayed in some countries because of its perceived costs in terms of lower activity. Adam and Bevan (2005) investigate the relationship between fiscal deficits and economic growth for a panel of 45 developing countries and find evidence of a 1.5 percent GDP threshold deficit effect. 58 No. 3, pp. 2, pp. (2010) note that emerging market economies typically exhibit a pro-cyclical fiscal policy, where governments increase (decrease) expenditures in economic expansions (recessions) and rise (reduce) tax rates in bad (good) times. All above economic views require assumptions to be presence such as no liquidity constraints, perfect financial markets in Ricardian equivalence. Moreover, the individuals in high indebted countries are more sensitive to the government expenditures in following the framework of neo-classical views. Easterly, W., Rodriguez, C.A. Blinder, A.S. and Solow, R.M. 1, pp. In fact, the non-linear relationships between fiscal policy and economic factors are examined under some manners. Learn more about fiscal policy in this article. THE EFFECTIVENESS OF VARIOUS FISCAL MEASURES TO STIMULATE THE ECONOMY In the debate on the ﬁ scal policy response to the economic downturn, the effectiveness of ﬁ scal stimulus measures and the appropriate composition of ﬁ scal stimulus packages to increase aggregate demand and stabilise the economy has recently gained importance. The public may expect that the increasing of government expenditures in this case be in along with the less favorable terms of government’s borrowings and less efficiency of spending, which then stimulate individuals to cut back their current consumption more and more. 571-597, available at: http://dx.doi.org/10.1016/j.jpubeco.2004.02.006, Afonso, A. and Strauch, R. (2007), “Fiscal policy events and interest rate swap spreads: evidence from the EU”, Journal of International Financial Markets, Institutions and Money, Vol. 14-31, available at: http://dx.doi.org/10.1016/j.japwor.2014.04.003, Kasselaki, M.T. Second, the fiscal policy is impacted by the political considerations such as the fiscal illusion of public and policy-makers, the favor of transferring current fiscal burden to future generations, the limitation of government due to the debt accumulation, the delay of fiscal consolidations due to the political conflicts, and the function of current budget institutions that leads to high spending. In addition, we examine the non-linear relationship between external debt and economic growth, where this relation is investigated more detail for its mechanism through the fiscal policy. 475-485. effectiveness of fiscal policy… Fiscal policy has been used as an antidote to weak activity during the most recent downturn and fiscal consolidation has been delayed in some countries because of its perceived costs in terms of lower activity. By dividing the sample into two sub-samples: the low indebted countries (group 1) and high indebted countries (group 2) and regress the impacts of government expenditure and institutions on economic growth. According to the review of Hemming et al. Below listed are 6 main factors that affect inventory management. Demographic pressures - these can affect the fiscal position too, for example an ageing population will cause an increase in government spending on the state pension; a fast-growing population (perhaps boosted by net inward migration) will also put more pressure on the government to fund essential public and merit goods. In addition, Wang et al. (1976), “Keynesian economics: the search for first principles”, Journal of Economic Literature, Vol. (2000), “Crowding‐out and crowding‐in effects of the components of government expenditure”, Contemporary Economic Policy, Vol. The data description shows that emerging market economies have high economic growth presenting by both average growth rates of GDP and GDP per capita. Many previous studies have investigated the effects of fiscal policy in many countries, especially in advanced countries such as USA, Japan, European area. 16 No. These factors include: Trade openness. Precisely, Dimakou (2015) finds that corruption constrains the fiscal capacity in taxations and increases the inflationary reliance. Methodology and data are provided in Section 3. 20 No. 3, pp. However, the impact of fiscal policy on aggregate demand depends on the responses of private saving to changes in fiscal stance. 31, pp. 3 No. Bouakez, H., Chihi, F. and Normandin, M. (2014), “Measuring the effects of fiscal policy”, Journal of Economic Dynamics and Control, Vol. Then, other empirical studies such as Easterly et al. The issue concerning the effect of fiscal policy on growth is quite old. Besides the presence of plentiful empirical literature in the effectiveness of fiscal policy, this field of study got much less evidence on the short-term effects in developing countries due to data deficiencies, the structural/institutional factors in the last century (see Hemming et al., 2002). Next section presents the methodology and data. 309-328, available at: http://dx.doi.org/10.1016/0047–2727(77)90052–4, Catão, L.A.V. The concluding remarks are discussed in Section 5. (2016), “Fiscal deficits, financial fragility, and the effectiveness of government policies”, Journal of Monetary Economics, Vol. This paper is structured as following. Monetary and Fiscal policy both have their pros and cons. Therefore, the study of the relationships between institutions, external debts and the effectiveness of fiscal policy is more significant for both literature and practice. 17 No. O While, the expected future revenue plays an important role in explaining the low fiscal limits of developing countries relating to developed countries (Bi et al., 2016). and Michaely, R. (1988), “Information quality and market efficiency”, Journal of Financial and Quantitative Analysis, Vol. This is done by increasing or decreasing the money supply by the monetary authority. and Tagkalakis, A.O. Would population aging affect the effectiveness of fiscal stimulus? For example while (Mangani, 2012) finds evidence of Price puzzle, (Mwabutwa etal, 2013) dispels this. 2, pp. These findings are consistence with literature and our arguments. Other control variables including capital formation, population growth, technology, foreign direct investment inflows, and trade openness have signs as expected by theories. This means that the high indebted countries have less fiscal room and the unfavorable terms in accessing the international financial markets, while the high level of external debt creates constraints for the private sectors so that their fiscal policies present the crowding-out effects. This view is also called as the crowding-in effects of fiscal policy, where the government should undertake the expenditure in the recession time to cover the lack of private consumption and investment (Jahan et al., 2014). Next, we estimate the growth model with the explanatory variables including both external debt to GNI and its square to examine the non-linear relationship between external debt and economic growth. As a result, the effectiveness of fiscal policy most likely depends on how it is paid in the future and the productivity of government expenditures (Hemming et al., 2002). fiscal policy: Government policy that attempts to influence the direction of the economy through changes in government spending or taxes. hand, has argued that fiscal deficits do not have any effect on key macroeconomic indicators such as investment, inflation and GDP growth. This result confirms the important role of fiscal policy in the case of emerging market economies, it is also consistence with our arguments and theory of Keynesian views. 3, pp. For instance, Amato and Tronzano (2000) find the evidence that the debt maturity and the share of foreign-denominated debt are crucial determinants of exchange rate stability in Italia. 3, pp. However, recently the extent to which fiscal policy affect growth has attracted both theoretical and empirical debate especially in the developing countries due to budget deficits, existing governance issues and their aspiration to move up the ladder of growth. The institution is defined as the social rules of the game (North, 1990), which includes “humanly devised,” “the rules of the game” to set “constraints” on human behavior, and the economic incentives (see North, 1981; Acemoglu and Robinson, 2008). Applying the endogenous growth model with the common elements of economic growth including labor, capital, technology, credit, trade openness, and capital flow, we then incorporate the government expenditure to investigate the effective of fiscal policy. This result also requires deeper investigation for the mechanism of this non-linear relationship. The empirical literature on the effects of fiscal policy on Pakistan's economic growth is still at its infancy, we surmise. 4, pp. Nevertheless, recent IMF evidence 4 from a wide panel of ﬁ scal policy responses to economic its effectiveness as a stabilisation instrument and the macroeconomic significance of public debt. Political factor Impact; Governments can raise or lower corporation tax. 18 No. 2, pp. Therefore, the assumptions of Ricardian view are not existed that propose for the Keynesian or neo-classical views of fiscal policy. To address this question, I examine 123-135. Similarly, the study of Kameda (2014a) finds that an increasing of 26-34 basis points in real ten-year interest rates in responding to a percentage point increase in both the projected/current deficit-to-GDP ratio and projected/current primary-deficit-to-GDP ratios in Japan. (1981), “Stabilization programs in developing countries: a formal framework”, Staff Papers, Vol. When policymakers seek to influence the economy, they have two main tools at their disposal—monetary policy and fiscal policy. Factors that affect the effectiveness of monetary policy. Previous, Khan and Knight (1981) find positive nominal income elasticities of government expenditures and taxes and they are close to unity in 29 developing countries. 13 No. Through GMM estimators for panel data, the study presents some meaningful findings. However, if governments change lump-sum taxes for the fiscal policy, the features of progressive taxes will have impacts on permanent income and then the aggregate demand and output. By doing this strategy, we believe that this study has significant contributions to both theory and practice. Factors that affect the effectiveness of monetary policy. (1984), “Are bond-financed deficits inflationary? Whereas, the government has to implement fiscal consolidation for the long-term sustainability of the economy. 3, pp. Literature available on monetary policy effectiveness still lacks synchrony. Accuracy of forecasting downturn and overheating in the economy. 65 No. 39, pp. Time lags. The long-term impact of inflation can damage the standard of living as much as a recession. Fiscal crises and aggregate demand: can high public debt reverse the effects of fiscal policy? We argue that the expansionary fiscal policy in the highly indebted countries not only creates the crowding-out effects for the private sectors through the impacts on interest rates and exchange rates, but also crowds out the availability of private sectors in accessing into the international financial markets that creates more constraints for private sectors to implement economic activities. We first examine the impacts of fiscal policy on economic growth through the modified model of endogenous growth theory by incorporating government expenditure and controlling other common drivers of economic growth including capital, labor, financial development, technology, economic openness (trade and capital flows). 2, pp. They find a strong positive relationship between deficits and inflation among high-inflation and developing country groups, but it is not true among low-inflation advanced economies. 1, pp. 1259-1289. What factors determine the effectiveness of discretionary fiscal policy What factors determine the.. What factors determine the effectiveness of discretionary fiscal policy Oct 04 2019 05:59 AM The results are consistent with literature and many previous empirical results. Thus, an emerging market economy with highly level of debts will determine the size of fiscal deficit in facing with more difficulties in assessing to international capital market (inaccessible or accessible with unfavorable terms), which then leads to the stronger crowding-out effects. As a result, this proposes higher crowding-out effects of fiscal policy. If the multiplier effect is large, then changes in government spending will have a bigger effect on overall demand. This is done by increasing or decreasing the money supply by the monetary authority. Factors affecting the size of fiscal multipliers Structural factors . Discretionary fiscal policy involves the same kind of lags as monetary policy. Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. 6, pp. To see how fiscal policy can affect the economy, consider a fiscal expansion that leads to rising demand, which, in turn, increases production. 369-380. This article is published under the Creative Commons Attribution (CC BY 4.0) licence. This condition in along with the assumptions of no liquidity constraints and perfect financial markets lead to no change in private consumption in general (Barro, 1974). Then, we apply the previous procedures to two sub-samples separately to investigate the effectiveness of fiscal policy under two debt regimes. 1, pp. 36-50. The fiscal policy is considered with a wide range of literature, while the effectiveness of fiscal policy is seen under its’ impacts on the economic growth and the long-term sustainable development. 34 No. Visit emeraldpublishing.com/platformupdate to discover the latest news and updates, Answers to the most commonly asked questions here, The Role of Institutions in Growth and Development, Fiscal deficits and growth in developing countries, Fiscal policy events and interest rate swap spreads: evidence from the EU, Journal of International Financial Markets, Institutions and Money, Crowding‐out and crowding‐in effects of the components of government expenditure, Governance regimes, corruption and growth: theory and evidence, Fiscal policy, debt management and exchange rate credibility: lessons from the recent Italian experience, The ‘crowding-out’ of private expenditure by fiscal actions: an empirical investigation, Fiscal policy is still an effective instrument of macroeconomic policy, Public debt and economic growth in India: a reassessment, Growth, governance, and fiscal policy transmission channels in low-income countries, The Ricardian approach to budget deficits, Trigger points and budget cuts: explaining the effects of fiscal austerity, Macroeconomic impacts of fiscal policy shocks in the UK: a DSGE analysis, Fiscal limits in developing countries: a DSGE approach, ‘Crowding out’ and the effectiveness of fiscal policy, Keynesian economics: the search for first principles, Friction in the trading process and the estimation of systematic risk, Fiscal policy and default risk in emerging markets. and Terrones, M.E. Both fiscal and monetary policy instruments can affect the level of income. (1998), “Democracy, economic freedom, fiscal policy, and growth in LDCs: a fresh look”, Economic Development and Cultural Change, Vol. 31-54. Mundell, R.A. (1963), “Capital mobility and stabilization policy under fixed and flexible exchange rates”, Canadian Journal of Economics and Political Science/Revue canadienne de economiques Et Science Politique, Vol. Governments employ fiscal policy to lower unemployment, limit inflation, reduce the impact of business cycles, and facilitate economic growth.Such goals are accomplished via government expenditure, business grants or loans, and revenue collection through taxation. (2001) add that the political pressures determine the path of government spending, taxations and borrowing in Greece in the period 1960-1972, which means the fiscal policy may not follow a long-term efficiency for the country. Williamson, O.E. Fiscal policies are pursued by state governments throughout the world and mainly related to spending and taxing programs. 408-415. and Singh, R.D. 1095-1117. Effectiveness of Fiscal Policy 3. 42 No. In between these two extreme views are the synthesists who advocate the middle path. In addition, the public sectors still strongly present in emerging market economies through the state-owned enterprises so that the fiscal policy has significant impacts on the whole economy through its effects on public sectors. However, the literature of fiscal policy is lacking of the studies about the effectiveness of fiscal policy under the contributions from the institutions and external debts in a comprehensive work. Meanwhile, empirical studies also provide evidences supporting for partial or/and fully existences of the Ricardian equivalence in developing countries such as Masson et al. Jahan, S., Mahmud, A.S. and Papageorgiou, C. (2014), “What is Keynesian economics”, Finance & Development, Vol. What do the worldwide governance indicators measure and quest, Institutional quality, financial development and OFDI, The economics of organization: the transaction cost approach, Institutional arrangements and debt financing, Research in International Business and Finance, https://doi.org/10.1108/JABES-05-2018-0009, http://creativecommons.org/licences/by/4.0/legalcode, http://dx.doi.org/10.1016/j.jpubeco.2004.02.006, http://dx.doi.org/10.1016/j.intfin.2005.12.002, http://dx.doi.org/10.1016/j.jce.2007.11.004, https://doi.org/10.1016/S0378–4266(99)00112–0, https://doi.org/10.1016/j.eap.2014.05.007, https://doi.org/10.1016/j.jmacro.2016.06.002, http://dx.doi.org/10.1016/j.jedc.2014.08.004, http://dx.doi.org/10.1016/0047–2727(77)90052–4, http://dx.doi.org/10.1016/j.jmoneco.2004.06.003, https://doi.org/10.1016/j.red.2009.07.002, https://doi.org/10.1016/j.ejpoleco.2015.07.004, https://doi.org/10.1016/j.econmod.2014.02.032, http://dx.doi.org/10.1016/j.jjie.2014.02.001, http://dx.doi.org/10.1016/j.japwor.2014.04.003, https://doi.org/10.1016/j.inteco.2016.03.003, https://doi.org/10.1016/j.jmoneco.2016.04.007, http://dx.doi.org/10.1016/j.japwor.2012.01.005, https://doi.org/10.1016/S0264–9993(00)00038–9, https://doi.org/10.1016/j.sbspro.2016.05.514, http://dx.doi.org/10.1016/j.pscr.2014.08.023, http://dx.doi.org/10.1016/j.ribaf.2015.10.006, Gross capital formation growth rate (% annual), Logarithm of domestic credit to private sector by banks, Logarithm of total patent applications by both residents and non-residents, Net inflows of foreign direct investment to GDP (%), General government final consumption expenditure growth rate (% annual). The discretionary fiscal policy does not always work as intended by the government. 57-78, available at: https://doi.org/10.1016/j.ejpoleco.2015.07.004, Doğan, İ. and Bilgili, F. (2014), “The non-linear impact of high and growing government external debt on economic growth: a Markov regime–switching approach”, Economic Modelling, Vol. 263-278. (2008), The Role of Institutions in Growth and Development, World Bank, Washington, DC. In this paper, we achieve our objectives by implementing following strategy. This result suggests the existence of crowding-in effects of fiscal policy in the context of emerging market economies. WP/02/208, IMF, Washington, DC. Meanwhile, the burdens of external debt on the sustainability of fiscal policy are also concerned. 6, pp. 24 No. Ho, P.-H., Lin, C.-Y. The results find significant evidences that the institutions enhance the effectiveness of fiscal policy. This relationship may explain the mechanism for the non-linear relationship between external debt and economic growth. Then, the institutional factors including government effectiveness, regulatory quality, and control of corruption are incorporated, respectively, to test the impacts of institutions on economic growth. Or, if the government expenditure is in line of an upward-trending stochastic process that individuals believe a sharply fall when it approaches a specific “target point,” there will be a non-linear relationship between private consumption and government expenditure (Bertola and Drazen, 1993). 7, pp. 105-124, available at: http://dx.doi.org/10.1016/j.jjie.2014.02.001, Kameda, K. (2014b), “What causes changes in the effects of fiscal policy? 52 No. (1974), “Analytical foundations of fiscal policy”. Despite of critics about bias or lack of comparability and the utility of institutional quality in World Governance Indicators (Thomas, 2010), there are many previous studies that use these indicators as the best proxies for institutional quality (see Zhang, 2016). 49, pp. Notably, the improvement in institutions promotes higher crowding-in effects of fiscal policy. 22 No. This result suggests that Vietnam should consider the fiscal policy as an effective policy in tackling the downturn of the economic growth. Hygiene factors include company policy, supervision, work conditions, salary, security, relationship with the boss, and relationships with peers. 362-372, available at: http://dx.doi.org/10.1016/j.ribaf.2015.10.006. 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