BIS CEMLA Roundtable on Fiscal Policy, public debt management and government bond markets: issues for central banks

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1 BIS CEMLA Roundtable on Fiscal Policy, public debt management and government bond markets: issues for central banks Is monetary policy constrained by fiscal policy? by Carlos Montoro November 212 The views expressed in this presentation are those of the author and do not necessarily reflect the position of the Bank for International Settlements 1

2 1) How do central banks assess the fiscal stance? Fiscal policy stance is a measure of the size of government policy intended to stabilise the economy. It may be captured by the budget balance. Issues: Coverage: central vs general government vs nonfinancial public sector balance (Graph 1). Cyclically-adjusted fiscal stance / effects of commodity prices (Graph 2) 2

3 Graph 1 Central and general government fiscal deficits As a percentage of GDP over Emerging Asia Latin America Other emerging markets Central government General government minus central government CN HK ID IN KR MY PH SG TH 15 AR BR CL CO MX PE VE AR = Argentina; BR = Brazil; CL = Chile; CN = China; CO = Colombia; CZ = Czech Republic; HK = Hong Kong SAR; HU = Hungary; ID = Indonesia; IL = Israel; IN = India; KR = Korea; MX = Mexico; MY = Malaysia; PE = Peru; PH = Philippines; PL = Poland; RU = Russia; SA = Saudi Arabia; SG = Singapore; TH = Thailand; TR = Turkey; VE = Venezuela; ZA = South Africa. Source: IMF, World Economic Outlook, September CZ HU PL RU TR IL SA ZA 15 3

4 Graph 2 Commodity prices in EMEs Share of output from commodities in EMEs 1 5 Commodity price elasticity of fiscal balance SA PE BR MX CL CO ZA AR ID MY IN VE RU.4.2. Commodity price elasticity of fiscal balance 2 SA RU VE MY IN ID CN AR CL CO ZA BR MX PL PE HU Share of output from commodities 1 AR = Argentina; BR = Brazil; CL = Chile; CN = China; CO = Colombia; HU = Hungary; ID = Indonesia; IN = India; MX = Mexico; MY = Malaysia; PE = Peru; PL = Poland; RU = Russia; SA = Saudi Arabia; VE = Venezuela; ZA = South Africa. 1 In per cent; Source: Céspedes and Velasco (211). 4

5 1 ) How far has fiscal policy become more countercyclical than in the past?, does it imply that monetary policy has to be less active in stabilising output? In the past, EMEs often found it difficult to implement countercyclical policies. Monetary policy was frequently subordinated to the requirements of fiscal policy (fiscal dominance). Graph 3: it seems that most EMEs were able to pursue countercyclical policies during the last decade. The policy mix varies considerably. 5

6 Graph 3 Countercyclical monetary and fiscal policies Emerging market economies Euro area Other advanced economies ID CZ MX BR CO PH HU PE RU TR CN TH KR CL 2 Monetary policy 4 1 GR BE FR IT NL DE AT FI LU IE 2 Monetary policy 4 1 NZ SE CH NO CA GB 8 4 US AU JP Monetary policy Fiscal policy Fiscal policy Fiscal policy 3 AT = Austria; AU = Australia; BE = Belgium; BR = Brazil; CA = Canada; CH = Switzerland; CL = Chile; CN = China; CO = Colombia; CZ = Czech Republic; DE = Germany; FI = Finland; FR = France; GB = United Kingdom; GR = Greece; HU = Hungary; ID = Indonesia; IE = Ireland; IT = Italy; JP = Japan; KR = Korea; LU = Luxembourg; MX = Mexico; NL = Netherlands; NO = Norway; NZ = New Zealand; PE = Peru; PH = Philippines; RU = Russia; SE = Sweden; TH = Thailand; TR = Turkey; US = United States. 1 Seemingly unrelated regression estimation of equations (3) and (4). For details, see Appendix Table A5. 2 Years without an (implicit) inflation target were excluded. 3 The horizontal axis shows how countercyclical fiscal policy is in output stabilisation ( of equation (4)). 4 The vertical axis shows how countercyclical monetary policy is in output stabilisation ( of equation (3)). Sources: IMF, World Economic Outlook; OECD, Economic Outlook; Bloomberg; Datastream; JPMorgan Chase; national data; BIS calculations. 4 6

7 2) What is the influence of fiscal policy on inflation? To what extent does fiscal dominance remain an issue for monetary policy? Fiscal policy may affect the ability of monetary policy to achieve inflation stability. Graph 4: EMEs seem to have taken steps to reduce the threat of fiscal dominance in the last decade. More conservative fiscal policies are weakly associated with lower inflation. 7

8 Graph 4 Fiscal and monetary policy interaction In per cent 199s excluding Russia and Venezuela 1, 2 2s excluding Russia and Venezuela 1, 3 SA IN TW CZ BR PL AR CN PH HU TH MY KR CL HK MX CO y = x where R 2 = IN HU MY PL TW AR IL CZ PH BR MX CN CO TH ZA ID HK PE KR CL SG SA TR y = x where R 2 = Overall deficit 4 SG Inflation Inflation 5 AR = Argentina; BR = Brazil; CL = Chile; CN = China; CO = Colombia; CZ = Czech Republic; HK = Hong Kong SAR; HU = Hungary; ID = Indonesia; IL = Israel; IN = India; KR = Korea; MX = Mexico; MY = Malaysia; PE = Peru; PH = Philippines; PL = Poland; RU = Russia; SA = Saudi Arabia; SG = Singapore; TH = Thailand; TR = Turkey; TW = Chinese Taipei; VE = Venezuela; ZA = South Africa. 1 Simple average. 2 For Hong Kong SAR, ; for Korea, Thailand, the Czech Republic, Hungary and Poland, ; for Brazil and Chile, ; for Argentina, ; for Russia, ; for Saudi Arabia, 1999; otherwise. 3 For Turkey, 22 1; 2 1 otherwise. 4 Corresponding to general government; as a percentage of GDP. 5 Annual changes in CPI. Sources: IMF, World Economic Outlook Database, September 211; national data. 8

9 3) To what extent has improved fiscal sustainability led to a permanent reduction in the real long-term interest rate? Fiscal policy might have substantial effects on monetary conditions, and thus on monetary policy, beyond its direct countercyclical effects. Sustainability concerns due to large deficits or high debt levels might put upward pressure on long-term interest rates. Graph 5: larger structural budget balances are associated with lower real interest rates, while equilibrium real interest rates are positively associated with government debt. 9

10 Graph 5 Budget balance, government debt and equilibrium real interest rates Budget balance equilibrium real interest rates 2 Government debt equilibrium real interest rates 3 HU TR CZ BR CN PE CO TH PH MX ID CL KR RU Budget balance Equilibrium interest rate BR = Brazil; CL = Chile; CN = China; CO = Colombia; CZ = Czech Republic; HU = Hungary; ID = Indonesia; KR = Korea; MX = Mexico; PE = Peru; PH = Philippines; RU = Russia; TH = Thailand; TR = Turkey. 1 Years without an (implicit) inflation target were excluded. 2 The horizontal axis shows b* from equation (2), ie the average general government net lending as a percentage of GDP, averages based on annual data. The vertical axis shows equilibrium real interest rates, ie r* from equation (3), averages based on quarterly data. 3 The horizontal axis shows the average general government debt as a percentage of GDP, averages based on annual data. The vertical axis shows equilibrium real interest rates, ie r* from equation (3), averages based on quarterly data. Sources: IMF, World Economic Outlook; OECD, Economic Outlook; Bloomberg; Datastream; JPMorgan Chase; national data; BIS calculations. CL RU CN KR PE TR CO TH MX PH ID BR HU CZ Government debt Equilibrium interest rate 1

11 4) How far is an increased stock of public sector assets seen as an offset of gross debt? What role may central bank foreign exchange assets play in influencing market perceptions about fiscal sustainability? Fiscal sustainability: often defined in terms of measures of gross or net debt, as well as the change in debt given by the current and the expected future primary balance. Gross vs net debt (Graph 6): Data for gross debt are more readily available than for net debt. Gross debt influences interest rates because it represents the total stock of debt that government s need to roll over. 11

12 Gross vs net debt (Graph 6): Investor s perceptions could also depend on net debt, especially in economies where the government holds a large stock of financial assets. Net debt: financial holdings of the government can be liquidated to offset a portion of the gross debt. Limitations of net debt: a portion of government s financial assets can represents future obligations (eg pension funds) Gross debt: may be an important indicator of shortterm fiscal vulnerability (if limits to market s ability to absorb the sale of financial assets) 12

13 Gross Net 1 Graph 6 General government debt 21 As a percentage of GDP SG IN MY TH PH HK CN KR ID BR AR MX VE CO PE CL HU IL PL TR CZ ZA RU SA AR = Argentina; B = Brazil; CL = Chile; CN = China; CO = Colombia; CZ = Czech Republic; DE = Germany; FR = France; GB = United Kingdom; HK = Hong Kong SAR; HU = Hungary; IL = Israel; ID = Indonesia; IN = India; IT = Italy; JP = Japan; KR = Korea; MX = Mexico; MY = Malaysia; PE = Peru; PH = Philippines; PL = Poland; RU = Russia; SA = Saudi Arabia; SG = Singapore; TH = Thailand; TR = Turkey; US = United States; VE = Venezuela; ZA = South Africa. 1 As of 29 for Russia; net debt data of Argentina, China, Czech Republic, Hong Kong SAR, India, Indonesia, Malaysia, Peru, Philippines, Singapore and Venezuela are not available. Sources: IMF, Government Finance Statistics; IMF, World Economic Outlook; CEIC; national data. 1 JP IT US DE FR GB 13

14 Sovereign wealth funds (SWFs) SWFs are typically excluded from debt sustainability calculations SWFs are government investment vehicles that are typically funded by foreign exchange assets by managed separately from the official foreign exchange reserve of the monetary authorities. The investment horizon of SWFs is longer than that of official reserves (primary goal long-run investment returns vs liquidity and security). Examples in the region: Chile, Mexico, Venezuela (Graph 7) 14

15 Graph 7 Main sovereign wealth funds (SWFs) by economy and size Advanced economies Emerging markets December 211, in billions of US dollars 1,2 1, CN AE NO SA SG KW HK RU US QA AU LY DZ KZ KR MY AZ IE BN FR IR CL CA NZ BR BH OM BW OT AE = United Arab Emirates; AU = Australia; AZ = Azerbaijan; BH = Bahrain; BN = Brunei Darussalam; BR = Brazil; BW = Botswana; CA = Canada; CL = Chile; CN = China; DZ = Algeria; FR = France; HK = Hong Kong SAR; IE = Ireland; IR = Iran; KR = Korea; KW = Kuwait; KZ = Kazakhstan; LY = Libya; MY = Malaysia; NO = Norway; NZ = New Zealand; OM = Oman; OT = other economies, including among others (by SWF size) Mexico, Italy, Venezuela and Indonesia; QA = Qatar; RU = Russia; SA = Saudi Arabia; SG = Singapore; US = United States. Source: Sovereign Wealth Funds Institute. 15

16 Fiscal sustainability issues: pension liabilities and demographics. Additional caveats to debt as a measure of fiscal sustainability are pension obligations and changing demographics. Pay-as-you-go pension systems (contributions used to fund immediate obligations) become unviable with aging populations (Graph 8). In Latin America the effect of ageing population seems low in comparison to other regions. Role of private pension systems. 16

17 Graph 8 Old-age dependency ratio 1 In per cent Emerging Asia Latin America Other EMEs China India Indonesia Korea Thailand Argentina Brazil Colombia Mexico Venezuela Poland Russia Saudi Arabia South Africa Turkey Ratio of the population aged 65 years or over to the population aged Sources: US Census Bureau; World Bank. 17

18 References Montoro, C, E Takáts and J Yetman (212) Is monetary policy constrained by fiscal policy?, BIS Papers N 67, 18