Discussion of Forni and Pisanis Expansionary Fiscal Policy and the Trade Balance: Evidence from a Ba

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Discussion ofForni and PisanisExpansionary
Fiscal Policy and the Trade Balance Evidence
from a Bayesian DSGE model for the euro area
byGiancarlo Corsetti (European University
Institute and CEPR)2nd BANK OF ITALY
CONFERENCE ONMACRO MODELING IN THE POLICY
ENVIRONMENT Banca dItalia 30 June-1 July, 2009,
Rome, Italy
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Pressing questions and recent debates

• Fiscal policy
• Size and sign of the multiplier (under what
  conditions)? Counterproductive?
• Interaction with (conventional and
  unconventional) monetary policy
• International spillovers (demand leakages and
  exchange rate)? Need for coordination?
• But what is the transmission mechanism? Some
  recent VAR results have revived old debates
  (consumption multiplier) but also questioned
  received wisdom on the transmission mechanism
• Exchange rates evidence of depreciation in
  response to positive spending shock for the US
  (and other countries)
• (Interest rate)
• Twin deficits for the US, evidence is mixed.

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What does the paper do

• Drawing on Adolfson et al. (2007) and Coenen et
  al. (2008) use Bayesian open economy DSGE model
  to assess the quantitative effects of fiscal
  shocks in the euro area vis-à-vis a (relatively
  more closed) foreign region (with no spillovers
  from the home region)
• Model is rich on the fiscal side (spending,
  taxes), and accounts for financial frictions
  including hand-to-mouth consumers
• focus on two key dimensions trade balance and
  international prices (real exchange rates)
• Preliminary, yet nice job!

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Main results

• Adds to skepticism on fiscal stabilization
• Output multiplier almost never above one
• Investment is crowded out in response to spending
  and transfers shocks, although is mildly crowded
  in by temporary reduction in taxes
• Consumption multiplier are negative in response
  to temporary hikes of spending on final goods and
  taxes on final goods contained if temporary
  public transfers
• consumption response is strong in response to
  temporary reduction in labour and consumption
  taxes
• gt Stress on the need for a sharper understanding
  of transmission (more later)
• Specific contribution to debate
• Find twin deficits for spending and transfers
• Terms of trade appreciate in response to shocks
  to spending, transfers, capital income taxes
  (depreciates with cuts in wage and consumption
  taxes)

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Focus of my comments Exchange Rates

• I focus on exchange rates. First some evidence. I
  draw from ongoing work with Gernot Mueller and
  Andre Meier.
• VAR evidence on the response of Spending shocks
  (augmented Blanchard-Perotti) for the US

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More evidence

• VAR evidence on the response of Spending shock
  for a sample of OECD countries (annual data)

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What is at stake? Theory

• Which model predicts a real exchange rate (terms
  of trade) depreciation in response to spending
  shocks?
• Not a new issue dubbed embarrassing failure of
  the Mundell Fleming model, by e.g. Dornbusch 1980
• Should we amend the standard GE models?
• F. Bilbiie T. Monacelli and R. Perotti (among
  others) stress complementarity between
  consumption and employment.
• M. Ravn, S. Schmidt-Grohe and M. Uribe emphasize
  deep habits in government consumption.
• Should we rethink the way we model fiscal policy?
• Joint work with A. Meier and G. Mueller stress
  on medium-term fiscal framework (spending
  reversals)

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What is at stake? Empirics

• Is depreciation specific to the US (UK, Canada
  and Australia, or to our sample average)?
• Beetsma, Giuliodori and Klaassen report real
  appreciation for European countries
• CMM provide some evidence that the transmission
  of spending is associated with appreciation under
  fixed exchange rates
• Is depreciation a by-product of
  mis-specification?
• However, depreciation seems to be detected also
  using Rameys approach to identification

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A key question

• Can (estimated) DSGE models like the one in the
  paper shed light on the above issues, both
  theoretically and empirically?
• The model imposes lots of structure on the data.
  The question is whether it is given a change to
  let the data pick the winner among alternative
  transmission mechanisms
• In the specification proposed in the draft,
  transmission is textbook. In response to spending
  and transfer shocks
• Consumption by ricardian households is crowded
  out
• Non-ricardian consume more but not enough to
  drive aggregate consumption up
• Why? The standard answer is wealth effects.
• But note that ricardian consumption rises in
  response to temporary cuts in consumption and
  wage taxes!

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A theoretical reconsideration

• In present discount value, the change in the tax
  burden due to the assumed temporary increase in
  spending and transfer is minuscule (zero in the
  tax experiments)
• What matters is the change in the intertemporal
  price of consumption and investment
• Consumption euler equation Change in the real
  return on a very long-term zero coupon bond
• With ricardian agent and a high degree of risk
  sharing, for a given the foreign monetary stance,
  this is mirrored by the rate of depreciation
• consumption, long real rate, real exchange rate
• In Figures 2-5 of the paper, appreciation is
  mirrored by a fall in ricardians consumption
• Interplay between fiscal shocks and asset prices

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Spending reversals

• Lets play the same theoretical tune in a
  different way
• As an empirically promising instance, embed in
  the model endogenous dynamic correction of
  current deficits (actually in the paper, eqs.
  19-21)
• Mix of cuts in spending (below trend) and rise in
  taxes (debt sensitivity of spending and taxes)
• If current spending shocks are partially reversed
  over time
• Anticipation of future spending cuts tends to
  lower future short real interest rates
• If prices are flexible, current long real rate
  rises nonetheless consumption of ricardian
  households fall
• With nominal rigidities, under a Taylor rule
  larger adjustment in output current long real
  rate may fall consumption of ricardian
  households rise

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Exogenous spending shocks/or no reversal
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Endogenous fiscal policy reversals
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Spending reversals flex price
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Spending reversals nominal rigidities
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Including hand-to-mouth consumers
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Taking stocks

• Explore more the issue of endogenous debt
  correction dynamics
• There is empirical evidence on debt sensitivity
  of spending (fiscal rule)
• For the US, one can estimate coefficients between
  -.02 and -.03
• The model does pick this up for the euro area.
  But effect is swamped by autoregressive
  coefficient

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Matching impulse responses (US)
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More to be done (policy and theory)

• Endogenous dynamic of budget (tax and spending)
  policy has direct bearing on policy
• Addresses issues raised by zero bound (see
  Christiano Eichenbaum and Rebelo Eggertsson)
• The model could be extended along other lines
• Non separability (Bilbiie, Monacelli-Perotti
  effects)
• Deep habits
• Report long rates!

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Only a word on twin deficit/divergence

• Difficult issue raised by Kim and Roubini. Once
  again
• Faulty theory?
• Faulty empirical specification?
• Once again, as is the model is geared towards
  generating twin deficits

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Conclusion

• Authors have setup a very good framework to
  address key issues in the current debate on
  fiscal policy
• Results so far suggest that textbook model of
  fiscal transmission can somehow frame the data
  for the euro area
• But what is the measure of success?
• Yet the model could do much more --- embed
  alternative transmission channels debated by
  recent literature
• Looking forward to see future versions of it