## _wp06244 - References

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### Introduction: context and literature
- Consensus on the crucial role of initial conditions, macroeconomic stabilization, and structural reforms on growth patterns in transition economies.
- Empirical literature nearly unanimous on the negative impact of inflation on growth; fiscal deficits and inflation effects on growth have not been fully disentangled.
- Fiscal balance less widely used in cross-country growth studies; only a few studies that include both inflation and fiscal balance find the fiscal balance to be a robust explanatory variable.
- Purfield (2003) finds no clear relationship between fiscal adjustment and growth in transition economies.
- Theoretical perspective (Agénor and Montiel, 1999): excessive fiscal deficits can lead to inflation, balance of payments difficulties, external debt crises, and high real interest rates—outcomes negatively correlated with economic growth.
- Empirical research in industrial countries finds improving fiscal positions can stimulate growth even in the short run; composition of fiscal adjustment is key.

### Research question and sample
- Objective: analyze whether the relationship between fiscal adjustment and growth in transition economies differs from industrial, emerging market, and low-income countries.
- Sample: 26 transition economies covering the period 1992–2001.
- Data sources: World Economic Outlook database (WEO); EBRD reform index; World Bank World Development Indicators (WDI).

### Summary of main findings
- The impact of fiscal adjustment on growth in transition economies is not qualitatively different from that in industrial, emerging market, and low-income economies.
- Correlation between fiscal adjustment and growth is stronger for countries that needed to achieve macroeconomic stability:
  - The largest fiscal adjustments were observed in the Commonwealth of Independent States (CIS).
  - Sustained consolidation efforts in the CIS were accompanied by accelerations in growth.
- For countries that had already achieved macroeconomic stability, the relationship between fiscal adjustment and growth is less clear; composition of spending and other factors matter more.
- Panel fixed-effects error-correction model controlling for initial conditions, structural reforms, and inflation confirms a strong positive correlation between fiscal adjustment and growth:
  - Positive effect holds in both the short and long run.
  - Results robust across specifications and estimation techniques.
  - CIS countries dominate the strong positive association.
- Two primary channels linking fiscal adjustment to higher growth:
  1. Reduced government borrowing requirements, curtailing the need to monetize deficits.
  2. Credibility effect signaling commitment to long-term fiscal sustainability and macroeconomic stability.
- These channels, together with structural reforms, spurred expansion in official and private capital flows that partially substituted previous net resource transfers and allowed aggregate demand recovery—principally reflected in consumption growth.
- As aggregate demand expands and full employment is reached, supply-side forces (capital accumulation, technological progress) likely regain importance.

### Policy implications
- Countries that have credibly stabilized and achieved fiscal sustainability are unlikely to obtain large additional growth benefits from further fiscal adjustment.
- Priority policies for such countries:
  - Address microeconomic distortions with structural reforms to increase the rate of return to investment and attract capital flows.
  - Improve the composition of government spending while maintaining a prudent fiscal stance.
  - Strengthen governance.

### Empirical methodology and econometric specification
- Three-stage approach:
  - Stage 1: characterize fiscal adjustment and growth data; compute standard deviations and coefficients of variation of fiscal balances.
  - Stage 2: panel-data analysis controlling for factors (e.g., terms-of-trade shocks, resource-rich countries); recognize limitations (parameter heterogeneity, omitted variables, multicollinearity, endogeneity, short series, data scope/quality).
  - Stage 3: qualitative country evidence to specify causal mechanisms and assess demand and supply channels.
- Econometric framework: one-equation error-correction model estimated by OLS with fixed effects.
  - Main estimating equation: ∆Yi,t = α + ∆Xi,t-1 βk + φ (Yi,t-1 - Xi,t-1 Υ) + εi,t
  - Rewritten/estimated as: ∆Yi,t = α + Yi,t-1 φ + ∆Xi,t-1 βk + Xi,t-1 .βj + εi,t
  - Interpretation notes: ∆ = first differences; Yi,t = real GDP; X = vector of independent variables; βk = short-term effects; φ = speed of adjustment; βj = - (φ Υ).
  - Persistent effects: sustained changes in Xi,t-1 have persistent effects proportional to (1+φ)^t where 0 < φ < -1 describes stated persistence properties.
- Included variables (measured in levels and first differences):
  - Structural reform index (REF, D_REF)
  - General government overall fiscal balance (GGB_Y, D_GGBY)
  - Inflation (WDIINF, D_WDIINF)
  - External current account balance (BCA_Y, D_BCAY)
- A simple three-variable vector accounts for over 70 percent of variation in the dependent variable in some specifications.
- Fixed effects capture country-specific factors and reduce omitted-variables bias.

### Descriptive statistics (as reported)
- Dependent variable:
  - D_NGDPR: Obs 234; Mean 0.95; Standard Dev. 7.88; Real GDP Growth; Source: WEO
- Independent variables:
  - GGB_Y: Obs 260; Mean -5.59; Standard Dev. 7.26; General Gov. Overall Fiscal Balance (in percent of GDP); Source: WEO
  - D_GGBY: Obs 234; Mean 0.85; Standard Dev. 5.21; Change in General Gov. Overall Fiscal Balance; Source: WEO
  - BCA_Y: Obs 260; Mean -5.54; Standard Dev. 11.68; Current Account Balance (in percent of GDP); Source: WEO
  - D_BCAY: Obs 234; Mean 0.06; Standard Dev. 10.18; Change in Current Account Balance; Source: WEO
  - WDIINF: Obs 202; Mean 164.75; Standard Dev. 566.11; Average Annual Consumer Price Index; Source: WDI
  - D_WDIINF: Obs 179; Mean -93.33; Standard Dev. 533.73; Change in Average Annual Consumer Price Index; Source: WDI
  - REF: Obs 240; Mean 3.12; Standard Dev. 0.80; EBRD Reform Index; Source: EBRD
  - D_REF: Obs 216; Mean 0.13; Standard Dev. 0.24; Change in Reform Index; Source: EBRD

### Stylized facts, stylized correlations, and regional heterogeneity
- Period split: Transition 1992–96; Post-transition 1997–2001.
- Between periods:
  - Average growth passed from about -2.0 percent to 4.5 percent.
  - Average fiscal deficit was cut in half from 7.0 to about 3.5 percent of GDP.
- Observed relationships:
  - Growth improved in over 75 percent of the cases.
  - Fiscal deficits were reduced in about two-thirds of the cases.
  - Simple correlations show a strong positive association between fiscal adjustment and growth (correlation only; no causal claim at this stage).
  - When fiscal adjustment exceeds about 10 percent of GDP, the impact on growth begins to decline (concavity).
- Fitted relationship (Figure 3): y = -0.0779x^2 + 1.4882x + 3.6951, R^2 = 0.4506.
- Sample averages reported (Table 2, 1992–2001):
  - Average GBAL 92-96 = -6.86
  - Average GBAL 97-01 = -3.67
  - Average Fiscal Adj. = 3.19
  - Average Growth 92-96 = -1.91
  - Average Growth 97-01 = 4.54
  - Average Growth Accel. = 6.44
- Regional patterns:
  - Positive relationship particularly strong for the CIS.
  - Large fiscal adjustment cases predominantly in CIS; in Eastern Europe only Bulgaria had comparable adjustment to a CIS country.
  - By 1992, most Central European countries (except Hungary and the Slovak Republic) had relatively low fiscal deficits; all Baltic countries had deficits below 3 percent of GDP.
  - In low-deficit starters, correlation between fiscal adjustment and growth is unclear; Baltics show strong growth despite low initial deficits, likely due to reforms and stabilization.
- Classification by fiscal adjustment (> or < 2.5% GDP) and growth acceleration (> or < 2.5 percentage points) places about 75 percent of cases on the diagonal (low-low or high-high). Notable exceptions discussed (Baltics, Belarus, Turkmenistan, Albania, Mongolia).

### Econometric results summary
- Estimation methods: OLS, robust regression, GLS, Arellano-Bond GMM.
- Findings:
  - Positive association between fiscal adjustment and growth in both short and long run.
  - Most lagged level and change in fiscal deficit parameter estimates statistically significant, in most cases at the 1 percent level (exception: Model 9 without inflation).
  - Long-run magnitude (Models 5 and 6): if country A maintained a fiscal deficit 1 percent of GDP lower than country B, long-term growth higher by between 0.5 and 1 percentage points, depending on model.
  - Short-run (first-difference) fiscal adjustment also positively impacts growth.
- CIS-specific effects:
  - Regression coefficient in the CIS sample about six times larger than non-CIS.
  - Partial regression results: non-CIS coef = .09101861, se = .11244212, t = .81; CIS coef = .62549993, se = .28445453, t = 2.2.
  - Excluding fixed effects, lagged fiscal deficit coefficient over five times larger in CIS.
- Other variables:
  - Reduction in inflation has a positive and highly significant effect on growth (WDIINF coefficients negative and significant).
  - Progress in reforms (EBRD index) strongly impacts growth but loses significance when inflation is included (multicollinearity).
  - Current account adjustment associated with a significant decline in growth in one specification (Model 5) but becomes insignificant when inflation is added.

### Qualitative analysis of CIS experiences and capital flows (Appendix I)
- CIS commonalities: overindustrialization, dependence on trade with other CMEA members, subsidized energy imports, significant pre-transition transfers and loans from the Soviet Union.
- Heterogeneity: some CIS countries are energy-rich (Russia, Turkmenistan, Azerbaijan, Kazakhstan); others are energy-importers (Armenia); several suffered conflicts (Armenia, Azerbaijan, Georgia, Tajikistan).
- Collapse of the Soviet Union generated severe terms-of-trade losses, cutoff of transfers/loans, output collapse, large fiscal deficits, limited access to debt financing, monetization of deficits, high inflation, and arrears.
- Capital flows and fiscal adjustment:
  - Rising foreign direct investment was the main private inflow, rising from below 2 percent of GDP per year early in transition to about 4 percent of GDP per year by 1999.
  - Remittances provided anecdotal private inflow.
  - Official flows rose sharply and were associated with rapid increases in debt levels; in CIS-7 public and publicly guaranteed debt constituted above 80 percent of total external debt.
- Demand vs supply drivers:
  - Evidence supports demand-driven recovery in the CIS during the 1990s: capital flows financed higher consumption; investment share of GDP remained constant or declined initially.
  - Only after 1998 did growth shift more toward exports and investment in export-oriented sectors.
  - Structural reforms (price liberalization, trade/exchange liberalization, privatization, competition) improved efficiency, attracted FDI, reduced quasi-fiscal operations, and facilitated fiscal adjustment.

### Cyclicality and sustainability of fiscal adjustment (Appendix II)
- Methodology to assess cyclicality:
  - Step 1: regress changes in revenues/expenditures on real GDP growth to estimate elasticities.
  - Step 2: estimate “automatic” changes implied by growth increases.
  - Step 3: net out automatic component to obtain cyclically adjusted fiscal adjustment.
- Rationale: short time series with structural breaks make regression-based elasticity estimates preferable to trend-extraction methods for these data.
- Findings on cyclicality:
  - Revenue and expenditure elasticities with respect to GDP tend to be very low in absolute value.
  - In most cases, the null of no effect of GDP growth on revenue/expenditure ratios cannot be rejected.
  - Cyclically adjusted fiscal adjustments are not very different from unadjusted ones.
  - Most countries classified as high fiscal adjustment remain so after cyclical correction; exceptions include Azerbaijan, Kazaksthan, and the Kyrgiz Republic.
- Panel result with fixed effects:
  - Change in Revenues = -0.33         ***
  - Change in Expenditures = -0.12         **
- Country-level cyclicality (Table 7 excerpts; values preserved exactly as reported):
  - Albania: 0.00; -0.23; 4.07; 1.00; 0.85; 0.15
  - Armenia: -0.09; -1.23; ***5.07; 16.65; 1.07; 15.58
  - Azerbaijan: 0.38; **; 0.18; 19.10; 3.27; 4.01; -0.74
  - Belarus: 0.17; 0.17; 8.85; 0.79; 1.86; -1.07
  - Bulgaria: 0.24; 0.05; 10.05; 6.17; 2.11; 4.06
  - Croatia: 0.15; 0.27; -1.42; -4.76; -0.30; -4.46
  - Czech Republic: 0.00; 0.05; -0.91; -1.92; -0.19; -1.73
  - Estonia: -0.25; -0.46; ***2.87; -1.18; 0.60; -1.78
  - Georgia: 0.06; 0.03; 6.33; 15.98; 1.33; 14.65
  - Hungary: 0.13; 0.31; 2.57; 2.53; 0.54; 1.99
  - Kazakhstan: 0.28; 0.15; 11.63; 2.47; 2.44; 0.03
  - Kyrgyz Republic: 0.01; 0.00; 8.42; 3.38; 1.77; 1.62
  - Latvia: -0.41; **; -0.41; ***5.18; -0.90; 1.09; -1.98
  - Lithuania: 0.02; -0.18; *; 6.19; -1.34; 1.30; -2.64
  - Macedonia: 0.06; -0.37; 3.38; 3.38; 0.71; 2.67
  - Moldova: -0.38; ***; -0.45; **; 9.91; 8.41; 2.08; 6.33
  - Mongolia: -0.97; -2.33; ***-0.22; 2.74; -0.05; 2.78
  - Poland: -0.32; -0.58; **; -2.32; -0.08; -0.49; 0.41
  - Romania: -0.16; -0.07; -1.81; -0.74; -0.38; -0.36
  - Russia: 0.24; 0.12; 9.58; 8.80; 2.01; 6.78
  - Slovak Republic: 0.64 ***; 1.01 **; -0.94; -1.13; -0.20; -0.94
  - Slovenia: -0.41; -0.27; 0.03; -1.21; 0.01; -1.22
  - Tajikistan: 0.01; 0.31; 16.41; 10.94; 3.45; 7.49
  - Turkmenistan: 0.44; 0.25; 26.00; -3.08; 5.46; -8.54
  - Ukraine: -0.05; 0.16; **; 15.68; 7.73; 3.29; 4.44
  - Uzbekistan: -0.12; 0.57; 3.86; 5.00; 0.81; 4.19
- Persistence and sustainability:
  - Fiscal adjustment generally sustained through time; coefficient of variation of fiscal deficit in 1996–2001 below 1 for most cases.
  - Only Russia and Macedonia have coefficients of variation exceeding 2.
  - No strong evidence of an important cyclical component in fiscal adjustment across the sample; cyclically adjusted classifications largely unchanged.

### Key statistics (selected tables and regional averages)
- Transition region averages (Table 5 reorganized):
  - Central and Eastern Europe average: GBAL 92-96 = -4.3; GBAL 97-01 = -4.0; Fiscal Adj. = 0.3; Growth 92-96 = 2.2; Growth 97-01 = 3.4; Growth Accel. = 1.3
  - Baltics average: GBAL 92-96 = -1.7; GBAL 97-01 = -2.9; Fiscal Adj. = -1.1; Growth 92-96 = -0.1; Growth 97-01 = 4.7; Growth Accel. = 4.7
  - Commonwealth of Independent States and Mongolia average: GBAL 92-96 = -10.0; GBAL 97-01 = -3.6; Fiscal Adj. = 6.4; Growth 92-96 = -5.5; Growth 97-01 = 5.4; Growth Accel. = 10.8
  - Overall Average: GBAL 92-96 = -6.9; GBAL 97-01 = -3.7; Fiscal Adj. = 3.2; Growth 92-96 = -1.9; Growth 97-01 = 4.5; Growth Accel. = 6.4
- Selected country examples (Table 5):
  - Poland: GBAL 92-96 = -3.8; GBAL 97-01 = -3.9; Fiscal Adj. = -0.1; Growth 92-96 = 5.8; Growth 97-01 = 3.5; Growth Accel. = -2.3
  - Russia: GBAL 92-96 = -10.2; GBAL 97-01 = -1.4; Fiscal Adj. = 8.8; Growth 92-96 = -5.6; Growth 97-01 = 4.0; Growth Accel. = 9.6
  - Ukraine: GBAL 92-96 = -9.7; GBAL 97-01 = -2.0; Fiscal Adj. = 7.7; Growth 92-96 = -12.5; Growth 97-01 = 3.2; Growth Accel. = 15.7
  - Azerbaijan: GBAL 92-96 = -5.7; GBAL 97-01 = -2.4; Fiscal Adj. = 3.3; Growth 92-96 = -9.5; Growth 97-01 = 9.6; Growth Accel. = 19.1
- Fiscal and external indicators (Table 6 averages 1992–1993 vs 2000–2001):
  - Overall Average: Total Revenues 92-93 = 35.2; Total Revenues 00-01 = 30.8; Total Expenditures 92-93 = 45.4; Total Expenditures 00-01 = 33.5; Overall Balance 92-93 = -10.2; Overall Balance 00-01 = -2.7; Change in TR = -5.6; Change in TE = -3.6; Current Account 92-93 = -4.4; Current Account 00-01 = -11.9
  - Central and Eastern Europe average: Total Revenues 92-93 = 39.0; Total Revenues 00-01 = 37.4; Total Expenditures 92-93 = 44.9; Total Expenditures 00-01 = 41.6; Overall Balance 92-93 = -5.9; Overall Balance 00-01 = -4.2; Change in TR = -5.5; Change in TE = -4.7; Current Account 92-93 = -1.6; Current Account 00-01 = -3.3
  - Baltics average: Total Revenues 92-93 = 33.5; Total Revenues 00-01 = 34.8; Total Expenditures 92-93 = 34.5; Total Expenditures 00-01 = 36.5; Overall Balance 92-93 = -1.0; Overall Balance 00-01 = -1.7; Change in TR = 2.7; Change in TE = -6.5; Current Account 92-93 = 1.3; Current Account 00-01 = 2.0
  - Commonwealth of Independent States and Mongolia average: Total Revenues 92-93 = 32.6; Total Revenues 00-01 = 24.8; Total Expenditures 92-93 = 48.3; Total Expenditures 00-01 = 26.6; Overall Balance 92-93 = -15.7; Overall Balance 00-01 = -1.8; Change in TR = -7.7; Change in TE = -1.9; Current Account 92-93 = -7.8; Current Account 00-01 = -21.7

*Source: IMF, World Economic Outlook and staff estimates (content from _wp06244 - 7.0 to about 3.5 percent of GDP.).*

### References..............................................................................................................

### _wp06244 - References

### Introduction: context and literature
- There is consensus on the crucial role of initial conditions, macroeconomic stabilization, and structural reforms on growth patterns in transition economies.
- Empirical literature is nearly unanimous on the negative impact of inflation on growth but has not been able to disentangle the separate effects of fiscal deficits and inflation on growth.
- The fiscal balance is much less widely used in cross-country studies of growth performance; only a few studies that use both inflation and the fiscal balance find the fiscal balance to be a robust explanatory variable.
- Purfield (2003) does not find a clear relationship between fiscal adjustment and growth in transition economies.
- Theoretical literature (Agénor and Montiel, 1999) emphasizes fiscal adjustment as crucial for macroeconomic stability; excessive fiscal deficits may lead to inflation, balance of payments difficulties, external debt crises, and high real interest rates—outcomes negatively correlated with economic growth.
- Empirical research supports salutary long-term effects of fiscal adjustment; some studies in industrial countries find improving fiscal positions can stimulate growth even in the short run, with composition of fiscal adjustment being key.

### Research question and sample
- Objective: analyze whether the relationship between fiscal adjustment and growth in transition economies differs from industrial, emerging market, and low-income countries.
- Sample: 26 transition economies covering the period 1992–2001.
- Data source: World Economic Outlook database of the International Monetary Fund (WEO); EBRD reform index; World Bank World Development Indicators (WDI).

### Summary of main findings
- The impact of fiscal adjustment on growth in transition economies is not qualitatively different from that observed in industrial, emerging market, and low-income economies.
- Correlation between fiscal adjustment and growth is stronger for countries that needed to achieve macroeconomic stability:
  - The largest fiscal adjustments in the sample were observed in the Commonwealth of Independent States (CIS).
  - Sustained consolidation efforts in the CIS have been accompanied by accelerations in growth in the sample.
- For countries that already achieved macroeconomic stability, the relationship between fiscal adjustment and growth is less clear; factors such as the composition of spending are more likely to affect growth.
- A fixed-effects panel-data error-correction model that controls for initial conditions, structural reforms, and inflation confirms a strong positive correlation between fiscal adjustment and growth:
  - The positive effect of fiscal adjustment seems to hold in both the short and long run.
  - Results are robust to a variety of model specifications and estimation techniques.
  - CIS countries play a dominant role in generating the strong positive association between fiscal adjustment and growth.
- Qualitative analysis of country experiences suggests two primary channels through which fiscal adjustment has been associated with higher growth:
  1. Reduced government borrowing requirements, which curtailed the need to monetize budget deficits.
  2. A credibility effect signaling political commitment to long-term fiscal sustainability and macroeconomic stability.
- These effects, together with structural reforms, spurred expansion in official and private capital flows that partially substituted for previous net resource transfers and allowed aggregate demand to recover—principally reflected in consumption growth in the years following the transitional recession.
- As aggregate demand expands and full employment is reached, supply-side growth forces based on capital accumulation and technological progress are likely to regain importance.

### Policy implications
- Countries that have credibly stabilized and achieved fiscal sustainability are unlikely to get large additional growth benefits from further fiscal adjustment.
- Priority policies for such countries include:
  - Addressing microeconomic distortions with structural reforms to increase the rate of return to investment and attract capital flows.
  - Improving the composition of government spending while maintaining a prudent fiscal stance.
  - Strengthening governance.

### Empirical methodology: three-stage approach
- Stage 1: Simple characterization of fiscal adjustment and growth data to establish stylized facts; compute standard deviations and coefficients of variation of fiscal balances to describe stability over time.
- Stage 2: Panel-data analysis controlling for other factors (e.g., terms-of-trade shocks, resource-rich countries) to limit omitted-variable bias. Recognized limitations include:
  - Parameter heterogeneity across countries and over time.
  - Omitted variables despite fixed effects.
  - Multicollinearity among independent variables.
  - Endogeneity and reverse causality; short time series and volatility limit corrective filtering.
  - Scope and quality of data: possible GDP underestimation and varying definitions of fiscal deficit across countries.
- Stage 3: Qualitative country evidence to specify causal mechanisms and assess demand and supply channels (resource allocation, income distribution, stabilization).

### Econometric model specification
- Framework: one-equation error-correction model estimated by OLS with fixed effects.
- Main estimating equation (as stated):
  - ∆Yi,t = α + ∆Xi,t-1 βk + φ (Yi,t-1 - Xi,t-1 Υ) + εi,t
  - Rewritten and estimated as: ∆Yi,t = α + Yi,t-1 φ + ∆Xi,t-1 βk + Xi,t-1 .βj + εi,t
- Interpretation:
  - ∆ operator denotes first differences.
  - Yi,t is real GDP in country i during year t.
  - X is a vector of independent variables; βk measures short-term effects; φ measures speed of adjustment to long-run equilibrium; βj = - (φ Υ).
  - The term φ (Yi,t-1 - Xi,t-1 Υ) measures deviations from the short-term equilibrium and is corrected at rate φ annually.
  - Sustained changes in Xi,t-1 have persistent effects proportional to (1+φ)^t where 0 < φ < -1 implies persistence properties described.
- Variables included (measured both in levels and first differences):
  - Structural reform index (REF, D_REF)
  - General government overall fiscal balance (GGB_Y, D_GGBY)
  - Inflation (WDIINF, D_WDIINF)
  - External current account balance (BCA_Y, D_BCAY)
- Simple three-variable vector accounts for over 70 percent of the variation in the dependent variable in some specifications.
- Fixed effects are used to capture country-specific factors and reduce omitted-variables bias.

### Descriptive statistics (Table 1 as reported)
- Dependent Variable:
  - D_NGDPR: Obs 234; Mean 0.95; Standard Dev. 7.88; Real GDP Growth; Source: WEO
- Independent Variables:
  - GGB_Y: Obs 260; Mean -5.59; Standard Dev. 7.26; General Gov. Overall Fiscal Balance (in percent of GDP); Source: WEO
  - D_GGBY: Obs 234; Mean 0.85; Standard Dev. 5.21; Change in General Gov. Overall Fiscal Balance; Source: WEO
  - BCA_Y: Obs 260; Mean -5.54; Standard Dev. 11.68; Current Account Balance (in percent of GDP); Source: WEO
  - D_BCAY: Obs 234; Mean 0.06; Standard Dev. 10.18; Change in Current Account Balance; Source: WEO
  - WDIINF: Obs 202; Mean 164.75; Standard Dev. 566.11; Average Annual Consumer Price Index; Source: WDI
  - D_WDIINF: Obs 179; Mean -93.33; Standard Dev. 533.73; Change in Average Annual Consumer Price Index; Source: WDI
  - REF: Obs 240; Mean 3.12; Standard Dev. 0.80; EBRD Reform Index; Source: EBRD
  - D_REF: Obs 216; Mean 0.13; Standard Dev. 0.24; Change in Reform Index; Source: EBRD

### Stylized facts: trends between periods
- Sample divided into two five-year periods:
  - Transition period: 1992–96.
  - Post-transition period: 1997–2001.
- Between the transition and post-transition periods:
  - The average growth rate passed from about -2.0 percent to 4.5 percent.
  - The average fiscal deficit was cut in half from about (text truncated at this point in the provided content).

*Content derived from the provided sections of the source PDF _wp06244 - References.*

### 7.0 to about 3.5 percent of GDP.

### _wp06244 - 7.0 to about 3.5 percent of GDP.

### Observed relationship between fiscal adjustment and growth
- Average fiscal deficit fell from "7.0 to about 3.5 percent of GDP."
- Growth improved in over "75 percent" of the cases.
- Fiscal deficits were reduced in about "two-thirds" of the cases.
- Simple correlations show a strong positive association between fiscal adjustment and growth (correlation only; no causal claim at this stage).
- When fiscal adjustment exceeds "about 10 percent of GDP", the impact on growth begins to decline (concavity of the curve).

### Descriptive patterns and graphical evidence
- Figure 3 plots change in the overall fiscal deficit (x-axis) and change in the growth rate (y-axis) between transition and post-transition periods; it shows:
  - (i) fiscal adjustment was generally associated with higher growth; and
  - (ii) the effect is greater the higher the initial level of the deficit.
- The fitted relationship in Figure 3: y = -0.0779x^2 + 1.4882x + 3.6951, R^2 = 0.4506.
- Table 2 (1992–2001) shows country-level GBAL 92-96, GBAL 97-01, Fiscal Adj., Growth 92-96, Growth 97-01, Growth Accel.; sample averages reported as:
  - Average GBAL 92-96 = "-6.86"
  - Average GBAL 97-01 = "-3.67"
  - Average Fiscal Adj. = "3.19"
  - Average Growth 92-96 = "-1.91"
  - Average Growth 97-01 = "4.54"
  - Average Growth Accel. = "6.44"
- Figures 1 and 2 categorize countries into groups (e.g., Group I: Low Fiscal Adjustment-Low Growth Acceleration; Group II: High Fiscal Adjustment-High Growth Acceleration) illustrating the general co-movement of improved fiscal balances and rising growth across country examples.

### Regional patterns and heterogeneity
- The positive relationship between fiscal adjustment and growth is particularly strong for the CIS.
- Large fiscal adjustment cases predominantly occurred in CIS countries; in Eastern Europe only Bulgaria had a fiscal adjustment comparable to that of a CIS country.
- By 1992:
  - Most Central European countries (except Hungary and the Slovak Republic) had relatively low fiscal deficits.
  - All Baltic countries had deficits below "3 percent of GDP."
- In countries with relatively low deficit levels at the beginning of the period, the correlation between fiscal adjustment and growth is unclear:
  - Central and Eastern European group: countries where the fiscal deficit increased from a relatively low position (e.g., the Czech Republic) experienced lower growth.
  - Baltic countries generally show strong growth despite low initial deficits, possibly due to structural reforms and macroeconomic stabilization.
- Classification by fiscal adjustment (High/Low > or < "2.5% GDP") and growth acceleration (> or < "2.5 percentage points") places about "75 percent" of cases on the diagonal (low-low or high-high). Notable exceptions:
  - Low fiscal adjustment and high growth acceleration: early adjusters (Baltics), commodity-price-driven cases (Belarus, Turkmenistan), outliers (Albania).
  - Mongolia: high fiscal adjustment and low growth acceleration (composition of adjustment—revenue-based—may explain the lack of growth acceleration).

### Econometric model results (summary)
- Econometric estimations (various specifications: OLS, robust regression, GLS, Arellano-Bond GMM) confirm a positive association between fiscal adjustment and growth in both short and long run.
- Most parameter estimates for the lagged level and change in the fiscal deficit are statistically significant, and in most cases at the "1 percent" level of significance (exception: Model 9 without inflation).
- Short-run (first-difference) and long-run (lagged level) fiscal variables both show positive associations with GDP growth.
- Magnitude of effect (discussion focuses on Models 5 and 6, robust to outliers):
  - Long run: if country A maintained a fiscal deficit "1 percent of GDP" lower than country B, long-term growth would be higher by between "0.5 and 1 percentage points," depending on the estimation model.
  - Short run: fiscal adjustment also has a positive impact on growth.
- The fiscal adjustment effect is much larger in the CIS:
  - Splitting the sample into CIS and non-CIS shows the regression coefficient in the CIS sample is about "six times larger."
  - Partial regression results presented: non-CIS coef = ".09101861, se = .11244212, t = .81"; CIS coef = ".62549993, se = .28445453, t = 2.2".
  - Running the same regression model (excluding fixed effects) indicates the lagged fiscal deficit coefficient is over "five times larger" in CIS countries.
- Other variable effects:
  - Reduction in inflation has a positive and highly significant effect on growth (WDIINF coefficients negative and significant in multiple models).
  - Progress in reforms (EBRD institutional reform index) has a strong impact on growth, but loses statistical significance when inflation is included due to multicollinearity (inflation stabilization is a component of the reform index).
  - Current account adjustment associated with a significant decline in growth in one specification (Model 5), but becomes insignificant when inflation is added.

### Qualitative analysis of CIS country experiences
- CIS common characteristics:
  - GDP concentrated in the industrial sector (overindustrialization) and extensive dependence on trade with other CMEA members.
  - Trade at non-market prices; energy imports heavily subsidized.
  - Significant transfers and loans from the Soviet Union financed budgets pre-transition.
- Heterogeneity across CIS:
  - Some countries had large natural resources (energy): Russia, Turkmenistan, Azerbaijan, Kazakhstan.
  - Others depended on energy imports (e.g., Armenia).
  - Several engaged in armed or civil conflicts: Armenia, Azerbaijan, Georgia, Tajikistan.
- Collapse of the Soviet Union generated:
  - Severe terms of trade loss as subsidized energy imports were phased out and relative prices rose.
  - Cutoff of transfers and loans from the Soviet Union, worsening macroeconomic imbalances.
  - Output collapse combined with fiscal transfer cuts generated large fiscal deficits.
  - Limited access to domestic or foreign debt financing and difficulty cutting public spending forced deficits to be monetized, leading to high inflation and arrears (including external arrears).
- These macroeconomic shocks contributed to large fiscal deficits and growing current account imbalances.

### Robustness and cyclicality
- Fiscal adjustment appears largely sustained through time and not driven by cyclical fluctuations:
  - Figure 5 (Appendix II) shows coefficients of variation of fiscal deficits were modest, indicating relative stability through time.
  - Table 7 (Appendix II) suggests both revenue and expenditure elasticities with respect to GDP are low, indicating limited cyclicality in fiscal adjustment.

*Source: IMF, World Economic Outlook and staff estimates (content from _wp06244 - 7.0 to about 3.5 percent of GDP.).*

### Appendix I).

### Appendix I)

### Fiscal adjustment, capital flows, and growth in transition economies
- Most CIS countries responded with fiscal adjustment and structural reforms, although to varying degrees.
- Countries with stronger fiscal adjustment efforts achieved stabilization faster.
- Rising foreign direct investment was the main form of private capital inflow to transition economies and followed a sharply rising trend during the 1990s.
  - While foreign direct investment averaged below 2 percent of GDP per year at the beginning of transition, by 1999 these flows reached about 4 percent of GDP per year.
- Anecdotal evidence suggests remittances were another source of private capital flows.
- Official flows rose sharply and were associated with rapid increases in debt levels.
  - Helbling, Mody, and Sahay (2004) document a large increase in external debt after 1992 in the CIS-7, with a significant share of public and publicly guaranteed debt in total external debt (above 80 percent).
  - The CIS-7 are Armenia, Azerbaijan, Georgia, the Kyrgyz Republic, Moldova, Tajikistan, and Uzbekistan.

### Demand- and supply-side drivers of the 1990s recovery
- Evidence supports the hypothesis that the GDP growth recovery in the CIS during the 1990s was driven by demand growth.
  - Accumulation of external debt in the CIS-7 was associated with large external current account deficits.
  - Capital flows financed higher consumption, while investment as a share of GDP either remained constant or declined.
  - Loukoianova and Unigovskaya (2004) argue that only after 1998 did growth start to be driven more by the expansion of exports and investment in export oriented sectors.
- Structural reforms reinforced the effects of fiscal adjustment on growth:
  - Price and market liberalization, liberalization of the exchange and trade system, privatization, and establishing a competitive environment contributed to efficiency improvements and attracted foreign direct investment.
  - Privatization and enforcing hard budget constraints on public enterprises reduced quasi-fiscal operations, facilitating fiscal adjustment by reducing implicit and explicit government subsidies.

### Main conclusions on fiscal adjustment and growth
- The impact of fiscal adjustment on growth in transition economies is not qualitatively different from industrial, emerging market, and low-income economies.
- Bivariate correlation analysis findings:
  - Strong positive correlation between fiscal adjustment and growth.
  - The correlation between fiscal adjustment and growth seems stronger the higher the initial level of the deficit.
  - When fiscal adjustment exceeds about 10 percent of GDP, the positive impact on growth begins to decline.
- The correlation is stronger for countries needing macroeconomic stability:
  - The largest fiscal adjustments observed predominantly in the CIS, which had unsustainable fiscal positions at the beginning of the 1990s.
  - Sustained consolidation efforts in the CIS accompanied the largest accelerations in growth in the sample.
- For countries that have already achieved macroeconomic stability, the correlation is less clear:
  - Other factors such as the composition of expenditures or deficit financing, or structural reforms with moderate up-front fiscal costs yielding long-term benefits, may play a bigger role.
  - Data limitations (consistency, validity, and reliability) did not allow deeper probing in this area.
- Panel-data econometric evidence:
  - A fixed-effects panel-data error-correction model that controls for initial conditions, structural reforms, and inflation confirms the strong positive relationship between fiscal adjustment and growth.
  - The positive effect of fiscal adjustment seems to hold in the short and long run.
  - Results are robust to a variety of model specifications and estimation techniques.
  - These findings confirm the dominant role of the CIS countries in generating the strong positive correlation between fiscal adjustment and growth in the sample.
- Two primary channels linking fiscal adjustment to higher growth in transition economies:
  - Reduced government borrowing requirements, which reduced the need to monetize budget deficits.
  - Enhanced policy credibility, signaling political commitment to long-term fiscal sustainability and macroeconomic stability.
- Interaction with capital flows and structural reforms:
  - These effects, together with structural reforms, spurred an expansion in official and private capital flows that partially substituted for the previous net resource transfer from the Soviet Union and allowed aggregate demand to recover.
  - Structural reforms improved resource allocation on the supply side and boosted growth, but capital-flow-driven aggregate demand recovery—principally reflected in consumption growth—likely dominated growth in the years following the transitional recession.

### Policy implications
- Countries that have credibly stabilized and achieved fiscal sustainability are unlikely to get large additional growth benefits from pursuing further fiscal adjustment.
- Recommended priorities in that context:
  - Address microeconomic distortions with structural reforms to increase the rate of return to investment and attract capital flows.
  - Improve the composition of government spending while maintaining a prudent fiscal stance.
  - Strengthen governance.

### Key statistics from Appendix tables (selected figures preserved exactly)
- Overall sample averages (Table 5 reorganized by transition regions):
  - Central and Eastern Europe average: GBAL 92-96 = -4.3; GBAL 97-01 = -4.0; Fiscal Adj. = 0.3; Growth 92-96 = 2.2; Growth 97-01 = 3.4; Growth Accel. = 1.3
  - Baltics average: GBAL 92-96 = -1.7; GBAL 97-01 = -2.9; Fiscal Adj. = -1.1; Growth 92-96 = -0.1; Growth 97-01 = 4.7; Growth Accel. = 4.7
  - Commonwealth of Independent States and Mongolia average: GBAL 92-96 = -10.0; GBAL 97-01 = -3.6; Fiscal Adj. = 6.4; Growth 92-96 = -5.5; Growth 97-01 = 5.4; Growth Accel. = 10.8
  - Overall Average: GBAL 92-96 = -6.9; GBAL 97-01 = -3.7; Fiscal Adj. = 3.2; Growth 92-96 = -1.9; Growth 97-01 = 4.5; Growth Accel. = 6.4
- Selected country examples (Table 5):
  - Poland: GBAL 92-96 = -3.8; GBAL 97-01 = -3.9; Fiscal Adj. = -0.1; Growth 92-96 = 5.8; Growth 97-01 = 3.5; Growth Accel. = -2.3
  - Russia: GBAL 92-96 = -10.2; GBAL 97-01 = -1.4; Fiscal Adj. = 8.8; Growth 92-96 = -5.6; Growth 97-01 = 4.0; Growth Accel. = 9.6
  - Ukraine: GBAL 92-96 = -9.7; GBAL 97-01 = -2.0; Fiscal Adj. = 7.7; Growth 92-96 = -12.5; Growth 97-01 = 3.2; Growth Accel. = 15.7
  - Azerbaijan: GBAL 92-96 = -5.7; GBAL 97-01 = -2.4; Fiscal Adj. = 3.3; Growth 92-96 = -9.5; Growth 97-01 = 9.6; Growth Accel. = 19.1
- Selected fiscal and external indicators (Table 6 averages for years 1992–1993 and 2000–2001):
  - Overall Average: Total Revenues 92-93 = 35.2; Total Revenues 00-01 = 30.8; Total Expenditures 92-93 = 45.4; Total Expenditures 00-01 = 33.5; Overall Balance 92-93 = -10.2; Overall Balance 00-01 = -2.7; Change in TR = -5.6; Change in TE = -3.6; Current Account (percent of GDP) 92-93 = -4.4; Current Account 00-01 = -11.9
  - Central and Eastern Europe average: Total Revenues 92-93 = 39.0; Total Revenues 00-01 = 37.4; Total Expenditures 92-93 = 44.9; Total Expenditures 00-01 = 41.6; Overall Balance 92-93 = -5.9; Overall Balance 00-01 = -4.2; Change in TR = -5.5; Change in TE = -4.7; Current Account 92-93 = -1.6; Current Account 00-01 = -3.3
  - Baltics average: Total Revenues 92-93 = 33.5; Total Revenues 00-01 = 34.8; Total Expenditures 92-93 = 34.5; Total Expenditures 00-01 = 36.5; Overall Balance 92-93 = -1.0; Overall Balance 00-01 = -1.7; Change in TR = 2.7; Change in TE = -6.5; Current Account 92-93 = 1.3; Current Account 00-01 = 2.0
  - Commonwealth of Independent States and Mongolia average: Total Revenues 92-93 = 32.6; Total Revenues 00-01 = 24.8; Total Expenditures 92-93 = 48.3; Total Expenditures 00-01 = 26.6; Overall Balance 92-93 = -15.7; Overall Balance 00-01 = -1.8; Change in TR = -7.7; Change in TE = -1.9; Current Account 92-93 = -7.8; Current Account 00-01 = -21.7

*Source: Appendix I, _wp06244 - Appendix I).*

### Appendix II. Cyclicality and Sustainability of Fiscal Adjustment

### Appendix II. Cyclicality and Sustainability of Fiscal Adjustment

### Methodology for Assessing Cyclicality
- Three-step procedure to assess direction of causality between fiscal adjustment and growth:
  - Step 1: For each country, regress the change in revenues and the change in expenditures from T to T+1 on real GDP growth to estimate revenue and expenditure growth elasticities.
  - Step 2: Estimate the “automatic” change in revenues and expenditures implied by the increase in growth from one period to the next.
  - Step 3: Adjust the observed fiscal adjustment by netting out the “automatic” component to obtain cyclically adjusted fiscal adjustment.
- Rationale for approach:
  - Time series for transition economies are short and can contain large shocks; regression-based elasticity estimates on short series with structural breaks are problematic but considered less problematic than extracting trend GDP (e.g., Hodrick-Prescott filter) for these data.
  - The notion of a “business cycle” as deviations around a trend is considered conceptually inadequate in this context.

### Findings on Cyclical Component of Fiscal Adjustment
- General findings:
  - Elasticity estimates of revenues and expenditures with respect to GDP tend to be very low in absolute value.
  - In most cases, the null hypothesis of no effect of GDP growth on the ratios of revenue and expenditures to GDP cannot be rejected.
  - Cyclically adjusted estimates of fiscal adjustment are not very different from unadjusted ones.
  - Most countries classified as cases of high fiscal adjustment remain so after cyclical correction, with exceptions: Azerbaijan, Kazaksthan, and the Kyrgiz Republic.
- Panel result:
  - Entire Panel with Fixed Effects: Change in Revenues = -0.33         *** ; Change in Expenditures = -0.12         ***

### Table 7 — Cyclical Component of Fiscal Adjustment (country-level values)
- Columns (when present in original): Change in Revenues; Change in Expenditures; Growth Accelerat.; Fiscal Adjust.; Cyclical Component of Fiscal Adjustment; Cyclically Adjusted Fiscal Adjustment.
- Country-level reported values (preserving all numeric values and formatting as in source):

  - Albania: 0.00; -0.23; 4.07; 1.00; 0.85; 0.15
  - Armenia: -0.09; -1.23; ***5.07; 16.65; 1.07; 15.58
  - Azerbaijan: 0.38; **; 0.18; 19.10; 3.27; 4.01; -0.74
  - Belarus: 0.17; 0.17; 8.85; 0.79; 1.86; -1.07
  - Bulgaria: 0.24; 0.05; 10.05; 6.17; 2.11; 4.06
  - Croatia: 0.15; 0.27; -1.42; -4.76; -0.30; -4.46
  - Czech Republic: 0.00; 0.05; -0.91; -1.92; -0.19; -1.73
  - Estonia: -0.25; -0.46; ***2.87; -1.18; 0.60; -1.78
  - Georgia: 0.06; 0.03; 6.33; 15.98; 1.33; 14.65
  - Hungary: 0.13; 0.31; 2.57; 2.53; 0.54; 1.99
  - Kazakhstan: 0.28; 0.15; 11.63; 2.47; 2.44; 0.03
  - Kyrgyz Republic: 0.01; 0.00; 8.42; 3.38; 1.77; 1.62
  - Latvia: -0.41; **; -0.41; ***5.18; -0.90; 1.09; -1.98
  - Lithuania: 0.02; -0.18; *; 6.19; -1.34; 1.30; -2.64
  - Macedonia: 0.06; -0.37; 3.38; 3.38; 0.71; 2.67
  - Moldova: -0.38; ***; -0.45; **; 9.91; 8.41; 2.08; 6.33
  - Mongolia: -0.97; -2.33; ***-0.22; 2.74; -0.05; 2.78
  - Poland: -0.32; -0.58; **; -2.32; -0.08; -0.49; 0.41
  - Romania: -0.16; -0.07; -1.81; -0.74; -0.38; -0.36
  - Russia: 0.24; 0.12; 9.58; 8.80; 2.01; 6.78
  - Slovak Republic: 0.64 ***; 1.01 **; -0.94; -1.13; -0.20; -0.94
  - Slovenia: -0.41; -0.27; 0.03; -1.21; 0.01; -1.22
  - Tajikistan: 0.01; 0.31; 16.41; 10.94; 3.45; 7.49
  - Turkmenistan: 0.44; 0.25; 26.00; -3.08; 5.46; -8.54
  - Ukraine: -0.05; 0.16; **; 15.68; 7.73; 3.29; 4.44
  - Uzbekistan: -0.12; 0.57; 3.86; 5.00; 0.81; 4.19

### Persistence and Sustainability of Fiscal Adjustment
- Importance: If fiscal adjustment is reversed year-to-year, theoretical channels (e.g., “crowding in” of private investment) explaining positive growth effects of consolidation are weakened because credibility is lacking.
- Empirical finding:
  - In most cases, observed fiscal adjustment was largely sustained through time.
  - The coefficient of variation of the fiscal deficit in the 1996–2001 period is below 1 for most cases.
  - Only two cases—Russia and Macedonia—have a coefficient of variation that exceeds 2, indicating greater volatility.
- Figure 5 description:
  - Presents the 10 cases where the fiscal deficit in the second period was more volatile.
  - Vertical axis range shown from 0.00 to 4.50; plotted countries include Armenia, Hungary, Kyrgyz Republic, Uzbekistan, Ukraine, Georgia, Azerbaijan, Tajikistan, Moldova, Kazakhstan, Bulgaria, Macedonia, Russia (labels displayed along the horizontal axis in the figure).

### Overall Assessment
- There is no strong evidence of an important cyclical component in fiscal adjustment across the transition economies sample.
- Cyclical corrections typically do not change the classification of high fiscal adjustment episodes, with a small number of exceptions.
- Fiscal consolidation episodes tend to be maintained rather than fully reversed, as indicated by generally low coefficients of variation of fiscal balances in 1996–2001.

*Source: Appendix II. Cyclicality and Sustainability of Fiscal Adjustment (from the supplied IMF content).*

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