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Fiscal Limits, External Debt, and Fiscal Policy in Developing Countries

Author/Editor: Huixin Bi | Wenyi Shen | Shu-Chun S. Yang
Authorized for Distribution: March 31, 2014
Electronic Access: Free Full Text (PDF file size is 323KB)
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Summary: This paper studies fiscal policy effects in developing countries with external debt and sovereign default risks. State-dependent distributions of fiscal limits are simulated based on macroeconomic uncertainty and fiscal policy specifications. The analysis shows that expected future revenue plays an important role in the low fiscal limits of developing countries, relative to those of developed countries. External debt carries additional risks since large devaluation of the real exchange rate can suddenly raise default probabilities. Consistent with majority views, fiscal consolidations are counterproductive in the short and medium runs. When an economy approaches its fiscal limits, government spending can be less expansionary than in a low-debt state. As more revenue is required to service debt in a high-debt state, higher tax rates raise the economic cost of increasing consumption, reducing the fiscal multiplier.
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Series: Working Paper No. 14/49
Subject(s): External debt | Fiscal policy | Fiscal consolidation | Government expenditures | Developing countries | Economic models
    Published:   March 31, 2014        
    ISBN/ISSN:   9781475521665/1018-5941   Format:   Paper
    Stock No:   WPIEA2014049   Pages:   37
    Price:   US$18.00
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