## _wp0908

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### I. INTRODUCTION
- Context:
  - Ongoing global downturn and financial turmoil increased calls for fiscal stimulus; many countries introduced/announced fiscal stimulus packages.
  - Re-ignited debate on effectiveness of fiscal policy as a counter-cyclical tool.
- Competing views summarized:
  - Supporters: economies may lack efficient mechanism to return to full potential.
  - Critics: economic agents may offset fiscal impact via changes in saving behavior.
  - Middle view: fiscal policy can be effective if conditions hold (sound macro fundamentals, nominal wage and price stickiness, finite horizons and liquidity constraints).
- Objective and approach:
  - Empirically analyze effectiveness of fiscal policy in stimulating economic activity in Singapore.
  - Use a structural vector autoregression (SVAR) framework to derive fiscal multipliers.
  - Discuss role for fiscal policy in the current downturn.
- Paper organization (sections noted): cross-country evidence; empirical approach and results for Singapore; role for fiscal policy in current downturn; concluding remarks.

### Cross-country evidence on the counter-cyclical role of fiscal policy
- General empirical stance:
  - Studies generally support a role for counter-cyclical measures, but size of fiscal multipliers varies with analytical approach.
- Event studies (selected findings):
  - 2001 income tax rebates in the United States: effective in boosting domestic demand but impact on output relatively small with multipliers well below 1 (Shapiro and others, 2002, 2003).
  - 1995 stimulus package in Japan: estimated successful but no lasting impact on economic activity (Posen (1998), Mühleisen (2000)).
  - Finland’s 1991 response: letting automatic stabilizers operate fully considered largely ineffective because it raised concerns about fiscal sustainability (Corsetti and Roubini, 1996).
  - IMF, World Economic Outlook (October 2008): size of public debt and composition of fiscal stimulus could be important determinants of effect of fiscal policy.
- VAR (SVAR) evidence for advanced economies:
  - Conclusion: fiscal multipliers have declined over time and, in some cases, may even have been negative (Perotti (2005)).
  - Likely reasons for decline:
    - increasing leakage through trade channel due to higher openness;
    - decline in share of liquidity constrained households due to better access to credit;
    - sharper focus of monetary policy on price stability.
- Macroeconometric model evidence:
  - Impact multipliers reported in the range of 0.3 to 1.2 percent.
  - Expenditure measures appear to have a larger effect than tax measures (Hemming and others 2002, Botman 2006).
  - IMF, World Economic Outlook (October 2008) find government investment has the largest impact on economic activity and inflation.
  - Size of estimated multipliers depends on assumptions about monetary regime, labor supply elasticities, and pervasiveness of liquidity constraints.
- Cross-country lessons on success factors:
  - Fiscal response needs to be well-timed (short implementation lags and/or large automatic stabilizers help).
  - Strong fundamentals (macroeconomic stability and fiscal sustainability) strengthen multiplier effects by lowering offsets from precautionary savings.
  - Fiscal measures need to be well-targeted to ensure largest possible demand impact.

### The counter-cyclical role of fiscal policy in Singapore — empirical approach
- Historical practice:
  - Fiscal policy used to counter adverse external shocks (1998 Asian crisis, 2001 tech-bubble, 2003 SARS).
  - FY 2008/09 measures focused on improving competitiveness and supporting household disposable income; FY 2009/10 budget expected to include counter-cyclical measures.
- Methodology (SVAR based on Blanchard and Perotti (2002)):
  - Data: seasonally adjusted quarterly data from 1990Q1 to 2007Q4.
  - Variables: zt = [yt et rt] where
    - yt = real private domestic demand;
    - et = real government expenditure;
    - rt = real current government revenue.
  - Estimation details:
    - VAR estimated in log levels with a constant, time dummies, and G7 growth as exogenous variable(s).
    - Number of lags chosen: five (as suggested by Akaike and other information criteria).
  - Identification steps:
    - Estimate reduced form VAR.
    - Calculate cyclically adjusted fiscal shocks using external estimates of cyclical elasticities.
    - Assume structural revenue shocks have no impact on structural spending shocks (= 0).
    - Use structural shocks as instruments to estimate impact on private domestic demand.
  - Assumed/estimated elasticities and simulation:
    - Expenditure elasticity with respect to changes in economic activity assumed close to zero within the quarter.
    - Elasticity of revenues estimated at around ½ percent within the quarter.
    - Monte Carlo simulations: 10000 replications.

### Empirical results for Singapore
- Main finding:
  - Discretionary fiscal policy can impact private domestic demand and play a role as a counter-cyclical tool, although the impact drops off quickly and eventually turns negative.
  - Estimated impulses generally not significant past the fourth quarter.
  - Sensitivity: results sensitive to estimated cyclicality of expenditures and revenues; near-term impact of revenue changes would almost double if elasticity was 0.75 rather than the 0.5 used.
- Factors likely contributing to short-lived impact:
  - Limited number of credit-constrained households → lower consumption response on the margin.
  - High propensity to save among households—possibly reflecting lack of a more comprehensive social safety net.
  - Use of nonbudgetary measures (e.g., changes in CPF contributions) not captured in fiscal variables used.
  - Strong monetary focus on price stability which may partly offset fiscal stimulus.
  - Significant leakages through trade as well as remittances; nonresident workers account for around 30 percent of the labor force.
- Multipliers and component findings:
  - Discretionary changes in revenues estimated to have a somewhat larger impact on private demand compared to changes in expenditure (Figure 2).
  - On a dollar-for-dollar basis (S$1 innovations), difference between revenues and expenditures is much smaller given relatively larger size of revenues (Figure 3).
  - Explanations for larger revenue multipliers:
    - Counter-cyclical measures often focused on easing corporate cost burden through tax measures.
    - Discretionary spending often focused on strengthening household saving (education, medical care, retirement) where high precautionary saving reduces immediate consumption impact.
    - Narrow expenditure definition excludes some income transfers (e.g., “Growth Dividends”) for lack of quarterly data, which could understate spending impact.
  - Expenditure composition:
    - One percent change in government current spending provides more impetus to private domestic demand than one percent change in public investment.
    - Dollar-for-dollar multipliers of consumption and investment are more or less the same given relative sizes.
    - Investment multipliers not highly significant.
  - By demand component:
    - Fiscal policy has larger estimated impact on private investment than on private consumption.
  - Inflation impact:
    - Fiscal expansion has a positive but limited impact on inflation; largest impact related to changes in taxes.
    - Government spending does not appear to have a significant impact on prices.
    - Inflation response initially positive then turns negative.
- Robustness and extensions:
  - Results sensitive to cyclicality assumptions and data coverage.
  - Suggested future work: analyze disaggregated fiscal measures, include income transfers based on complete data set, further sensitivity analysis.

### The role for fiscal policy in the current downturn (policy implications)
- Rationale:
  - Despite relatively short-lived SVAR impacts, fiscal policy should play a key stabilizing role given heightened uncertainty and considerable downside risks.
- Singapore’s fiscal space:
  - Large fiscal reserves and structural surplus provide ample room for counter-cyclical policy.
  - Constitutional amendment expanding annual access to returns from fiscal reserves invested by Government of Singapore Investment Corporation and Temasek Holdings increases this room.
- Operational considerations:
  - Singapore’s relatively small automatic stabilizers imply reliance on discretionary measures.
  - Advantage: short fiscal implementation lags allow fast discretionary response.
  - Effectiveness criteria for stimulus:
    - timely (i.e., presented with the upcoming budget),
    - significant (given considerable downside risks),
    - prolonged (in light of the protracted nature of the slowdown).
  - Importance of signalling willingness to do more if needed to reduce precautionary saving and safeguard effectiveness.
- Composition of stimulus (options discussed):
  - Revenue measures:
    - Personal income tax credits: effective through fast and targeted distribution.
    - Lowering corporate income, dividend, and capital gains taxation: often effective in normal times but may be less effective in current weak environment due to cyclical decline in tax bases.
    - Possible temporary tax credit on new investment and temporary reduction in consumption taxes; noted limitations of consumption tax cut: (i) not as well targeted; (ii) may not boost disposable incomes if prices remain unchanged; (iii) may not spur consumption in environment of waning confidence.
  - Expenditure measures:
    - Targeted cash transfers: quick to disburse and support neediest with highest propensity to consume.
    - Expanding social safety nets: could reduce precautionary savings but may take time to implement (medium-term).
    - Frontloading existing investment projects and stepping up maintenance spending: more immediate impact on demand.

### Concluding remarks
- Historical precedent: Singapore has a history of relying on fiscal policy to counter external shocks.
- SVAR-based empirical results indicate fiscal policy can be used for demand management but impacts may be short-lived due to:
  - absence of credit-constrained agents,
  - high household propensity to save,
  - quasi-fiscal measures not captured in budget data,
  - monetary focus on price stability,
  - openness/leakages.
- Policy prescription:
  - Fiscal policy should play a key stabilizing role in the current downturn given downside risks and large fiscal space.
  - For effectiveness, fiscal stimulus should be timely, well-targeted, significant, and prolonged; signalling readiness to do more is important.
  - A fiscal stimulus package could include both revenue and expenditure measures.

*Source: _wp0908 - References / Section V presents concluding remarks.*

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

### _wp0908 - References..........................................................................................................

### Figures
- 1.  Fiscal Multipliers from SVAR and Macroeconometric Models— Cross-Country Evidence .................................................................................... 4
- 2.  Fiscal Multipliers—SVAR Results....................................................................... 10
- 3.  Fiscal Multipliers—SVAR Results....................................................................... 11

### I. INTRODUCTION
- The spillovers from the ongoing global downturn and financial turmoil has increased calls in many countries for fiscal stimulus to cushion the impact on domestic economic activity and many countries have already introduced/announced fiscal stimulus packages.
- This has re-ignited the long-standing debate among economists about the effectiveness of fiscal policy as a counter-cyclical tool.
- Competing views:
  - Supporters of an active role for fiscal policy suggest that economies lack an efficient mechanism to return to full potential.
  - Critics argue that economic agents will offset the impact of fiscal policy on aggregate demand through changes in their saving behavior.
  - A middle-of-the-road view holds that fiscal policy can be effective provided certain conditions hold, including sound macroeconomic fundamentals, nominal wage and price stickiness, and/or economic agents with finite horizons and liquidity constraints.
- This paper analyzes empirically the effectiveness of fiscal policy in stimulating economic activity in Singapore.
- The empirical approach is based on a structural vector autoregression (SVAR) framework to derive fiscal multipliers.
- In this context, the paper also discusses the role for fiscal policy in addressing the current economic downturn.
- Organization of the paper:
  - Section II looks at the cross-country evidence on the counter-cyclical role of fiscal policy;
  - Section III presents the empirical approach and results for Singapore;
  - Section IV discusses the role for fiscal policy in the current downturn;

*Source: _wp0908 - References..........................................................................................................*

### Section V presents concluding remarks.

### Section V presents concluding remarks.

### Cross-country evidence on the counter-cyclical role of fiscal policy
- General empirical stance: studies generally support a role for counter-cyclical measures, but evidence on the size of fiscal multipliers varies with the analytical approach.
- Event studies: mixed results
  - 2001 income tax rebates in the United States: effective in boosting domestic demand but impact on output relatively small with multipliers well below 1 (Shapiro and others, 2002, 2003).
  - 1995 stimulus package in Japan: estimated successful but no lasting impact on economic activity (Posen (1998), Mühleisen (2000)).
  - Finland’s 1991 response: letting automatic stabilizers operate fully considered largely ineffective because it raised concerns about fiscal sustainability (Corsetti and Roubini, 1996).
  - IMF, World Economic Outlook (October 2008): size of public debt and composition of fiscal stimulus could be important determinants of the effect of fiscal policy.
- VAR (SVAR) evidence for advanced economies:
  - Conclusion: fiscal multipliers have declined over time and, in some cases, may even have been negative (Perotti (2005)).
  - Likely reasons for decline: (i) increasing leakage through the trade channel due to higher openness; (ii) decline in share of liquidity constrained households due to better access to credit; (iii) sharper focus of monetary policy on price stability.
- Macroeconometric model evidence:
  - Impact multipliers in the range of 0.3 to 1.2 percent.
  - Expenditure measures appear to have a larger effect than tax measures (Hemming and others 2002, Botman 2006).
  - IMF, World Economic Outlook (October 2008) find government investment has the largest impact on economic activity and inflation.
  - Size of estimated multipliers depends on assumptions about monetary regime, labor supply elasticities, and pervasiveness of liquidity constraints.
- Cross-country lessons on success factors:
  - Fiscal response needs to be well-timed (short implementation lags and/or large automatic stabilizers help).
  - Strong fundamentals (macroeconomic stability and fiscal sustainability) strengthen multiplier effects by lowering offsets from precautionary savings.
  - Fiscal measures need to be well-targeted to ensure largest possible demand impact.

### The counter-cyclical role of fiscal policy in Singapore — empirical approach
- Historical practice: fiscal policy used to counter adverse external shocks (1998 Asian crisis, 2001 tech-bubble, 2003 SARS); FY 2008/09 measures focused on improving competitiveness and supporting household disposable income; FY 2009/10 budget expected to include counter-cyclical measures.
- Methodology: SVAR framework based on Blanchard and Perotti (2002)
  - Intuition: use “inside” lags of fiscal policy to identify discretionary structural fiscal shocks; within-quarter fiscal reactions represent automatic responses; seasonally adjusted quarterly data from 1990Q1 to 2007Q4 used; VAR estimated in log levels with a constant, time dummies, and G7 growth as exogenous variable(s).
  - Model specification: zt = [yt et rt] where yt = real private domestic demand; et = real government expenditure; rt = real current government revenue.
  - Number of lags chosen: five (as suggested by Akaike and other information criteria).
  - Identification steps: estimate reduced form VAR, calculate cyclically adjusted fiscal shocks using external estimates of cyclical elasticities, assume structural revenue shocks have no impact on structural spending shocks (= 0), use structural shocks as instruments to estimate impact on private domestic demand.
  - Assumed/estimated elasticities: expenditure elasticity with respect to changes in economic activity assumed close to zero within the quarter; elasticity of revenues estimated at around ½ percent within the quarter.
  - Monte Carlo simulations: 10000 replications.

### Empirical results for Singapore
- Main finding: discretionary fiscal policy can impact private domestic demand and play a role as a counter-cyclical tool, although the impact drops off quickly and eventually turns negative.
  - Estimated impulses generally not significant past the fourth quarter.
  - Sensitivity: results sensitive to estimated cyclicality of expenditures and revenues; near-term impact of revenue changes would almost double if elasticity was 0.75 rather than the 0.5 used.
- Factors likely contributing to short-lived impact:
  - Limited number of credit-constrained households → lower consumption response on the margin.
  - High propensity to save among households—possibly reflecting lack of a more comprehensive social safety net.
  - Use of nonbudgetary measures (e.g., changes in CPF contributions) not captured in fiscal variables used.
  - Strong monetary focus on price stability which may partly offset fiscal stimulus.
  - Significant leakages through trade as well as remittances; nonresident workers account for around 30 percent of the labor force.
- Multipliers and component findings:
  - Discretionary changes in revenues estimated to have a somewhat larger impact on private demand compared to changes in expenditure (Figure 2).
  - On a dollar-for-dollar basis (S$1 innovations), difference between revenues and expenditures is much smaller given relatively larger size of revenues (Figure 3).
  - Explanations for larger revenue multipliers:
    - Counter-cyclical measures often focused on easing corporate cost burden through tax measures.
    - Discretionary spending often focused on strengthening household saving (education, medical care, retirement) where high precautionary saving reduces immediate consumption impact.
    - Narrow expenditure definition excludes some income transfers (e.g., “Growth Dividends”) for lack of quarterly data, which could understate spending impact.
  - Among expenditure components: one percent change in government current spending provides more impetus to private domestic demand than one percent change in public investment; but dollar-for-dollar multipliers of consumption and investment are more or less the same given relative sizes. Investment multipliers not highly significant.
  - By demand component: fiscal policy has larger estimated impact on private investment than on private consumption.
  - Inflation impact: fiscal expansion has a positive but limited impact on inflation; largest impact related to changes in taxes; government spending does not appear to have a significant impact on prices; inflation response initially positive then turns negative.
- Robustness and extensions:
  - Results sensitive to cyclicality assumptions and data coverage.
  - Suggested future work: analyze disaggregated fiscal measures, include income transfers based on complete data set, further sensitivity analysis.

### The role for fiscal policy in the current downturn (policy implications)
- Despite relatively short-lived SVAR impacts, fiscal policy should play a key stabilizing role given heightened uncertainty and considerable downside risks.
- Singapore’s fiscal space:
  - Large fiscal reserves and structural surplus provide ample room for counter-cyclical policy.
  - Constitutional amendment expanding annual access to returns from fiscal reserves invested by Government of Singapore Investment Corporation and Temasek Holdings increases this room.
- Operational considerations:
  - Singapore’s relatively small automatic stabilizers imply reliance on discretionary measures.
  - Advantage: short fiscal implementation lags allow fast discretionary response.
  - To be effective, fiscal stimulus should be:
    - timely (i.e., presented with the upcoming budget),
    - significant (given considerable downside risks),
    - prolonged (in light of the protracted nature of the slowdown).
  - Importance of signalling willingness to do more if needed to reduce precautionary saving and safeguard effectiveness.
- Composition of stimulus:
  - Diversified package of both revenue and expenditure measures could be considered.
  - Revenue measures:
    - Personal income tax credits: effective through fast and targeted distribution.
    - Lowering corporate income, dividend, and capital gains taxation: often effective in normal times but may be less effective in current weak environment due to cyclical decline in tax bases.
    - Possible temporary tax credit on new investment and temporary reduction in consumption taxes; limitations of consumption tax cut: (i) not as well targeted; (ii) may not boost disposable incomes if prices remain unchanged; (iii) may not spur consumption in environment of waning confidence.
  - Expenditure measures:
    - Targeted cash transfers: quick to disburse and support neediest with highest propensity to consume.
    - Expanding social safety nets: could reduce precautionary savings but may take time to implement (medium-term).
    - Frontloading existing investment projects and stepping up maintenance spending: more immediate impact on demand.

### Concluding remarks
- Singapore has a history of relying on fiscal policy to counter external shocks.
- SVAR-based empirical results indicate fiscal policy can be used for demand management but impacts may be short-lived due to: absence of credit-constrained agents, high household propensity to save, quasi-fiscal measures not captured in budget data, monetary focus on price stability, and openness/leakages.
- Despite short-lived impacts, fiscal policy should play a key stabilizing role in the current downturn given downside risks and large fiscal space.
- For effectiveness, fiscal stimulus should be timely, well-targeted, significant, and prolonged; signalling readiness to do more is important.
- A fiscal stimulus package could include both revenue and expenditure measures.

*Source: _wp0908 - Section V presents concluding remarks.*

### REFERENCES

### _wp0908 - REFERENCES

### Fiscal policy theory and general equilibrium
- Baxter, Marianne and Robert G. King, 1993, “Fiscal Policy in General Equilibrium,” American Economic Review, Vol. 83(3), pp. 315–34, (June).
- Blinder, Alan, 2004, “The Case against the Case against Discretionary Fiscal Policy,” CEPS Working Paper No. 100 (New Jersey: Princeton University, Department of Economics, Center for Economic Policy Studies).
- Linnemann, Ludger and Andreas Schabert, 2003, “Fiscal Policy in the New Neoclassical Synthesis,” Journal of Money, Credit, and Banking, Vol. 35, No. 6, pp. 911–929.
- Hemming Richard, Michael Kell, and Selma Mahfouz, 2002, “The Effectiveness of Fiscal Policy in Stimulating Economic Activity—A Review of the Literature,” IMF Working Paper 02/208 (Washington: International Monetary Fund).

### Empirical estimates of fiscal multipliers and transmission
- Blanchard, Olivier and Roberto Perotti, 2002, “An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output,” Quarterly Journal of Economics 117, 1329–1368.
- De Castro Fernández, Francisco and Pablo Hernández de Cos, 2006, “The Economic Effects of Exogenous Fiscal Shocks in Spain: A SVAR Approach,” ECB Working Paper, Vol. 647 (Frankfurt: European Central Bank).
- Heppke-Falk, Kirsten H., Jörn Tenhofen, and Guntram B. Wolff, 2006, “The Macroeconomic Effects of Exogenous Fiscal Policy Shocks in Germany: A Disaggregated SVAR Analysis,” Discussion Paper, Series 1: Economic Studies, 41/2006, (Frankfurt: Deutsche Bundesbank, Research Centre).
- Giordano, Raffaela, Sandro Momigliano, Stefano Neri, and Roberto Perotti, 2007, “The Effects of Fiscal Policy in Italy: Evidence from a VAR Model,” European Journal of Political Economy 23, 707–33.
- Perotti, Roberto, 2005, “Estimating the Effects of Fiscal Policy in OECD Countries,” CEPR Discussion Paper 4842 (London: Centre for Economic Policy Research).
- Perotti, Roberto, 2007, “In Search of the Transmission Mechanism of Fiscal Policy,” NBER Working Paper 13143 (Cambridge, Massachusetts: National Bureau of Economic Research).

### Fiscal consolidation, solvency, and political economy
- Corsetti, Giancarlo and Nouriel Roubini, 1996, “Budget Deficits, Public Sector Solvency and Political Biases in Fiscal Policy: A Case Study of Finland,” Finnish Economic Papers, Vol. 9, Issue 1, (Spring), pp. 18–36.
- Giavazzi, Francesco and Marco Pagano, 1990, “Can Severe Fiscal Contractions be Expansionary? Tales of Two Small European Countries,” NBER Macro Annual 5, 75–111 (Cambridge, Massachusetts: National Bureau of Economic Research).

### DSGE, modeling, and Fund analytical methods
- Botman Dennis, Phillip Karam, Douglas Laxton, and David Rose, 2007, DSGE Modeling at the Fund: Applications and Further Developments,” IMF Working Paper 07/2007 (Washington: International Monetary Fund).

### Japan and post-bubble experience
- Bayoumi, Tamim, 2001, “The Morning After: Explaining the Slowdown in Growth in the 1990s,” in Post-Bubble Blues––How Japan Responded to Asset Price Collapse ed. by T. Bayoumi and Charles Collyns (Washington: International Monetary Fund).
- Mühleisen, Martin, 2000, “Too much of a Good Thing? The Effectiveness of Fiscal Stimulus” in Post-Bubble Blues-How Japan Responded to Asset Price Collapse, ed. by T. Bayoumi and Charles Collyns (Washington: International Monetary Fund).
- Kuttner, Kenneth and Adam Posen, 2002, “Fiscal Policy Effectiveness in Japan,” Journal of the Japanese and International Economies 16, 536–558.
- Posen, Adam, 1998, “Restoring Japan’s Economic Growth,” (Washington: Institute for International Economics).

### Consumer spending, tax rebates, and micro evidence
- Johnson, David S., Jonathan A. Parker, and Nicholas S. Souleles, 2004, “The Response of Consumer Spending to the Randomized Income Tax Rebates of 2001,” The Wharton School Working Paper, (New Jersey: Bureau of Labor Statistics, Princeton University).
- Shapiro, Matthew D. and Joel Slemrod, 2003, “Consumer Response to Tax Rebates,” American Economic Review, Vol. 93 (1), 381–396.
- Shapiro, Matthew D. and Joel Slemrod, 2002, “Did the 2001 Tax Rebate Stimulate Spending? Evidence from Taxpayer Surveys,” NBER Working Paper 9308 (Cambridge, Massachusetts: National Bureau of Economic Research).

### IMF World Economic Outlook publications
- International Monetary Fund, 2008a, World Economic Outlook, April 2008: Housing and the Business Cycle, World Economic and Financial Surveys (Washington).
- International Monetary Fund, 2008b, World Economic Outlook, October 2008: Financial Stress, Downturns, and Recoveries, World Economic and Financial Surveys (Washington)

*Source: _wp0908 - REFERENCES*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2009/_wp0908.pdf_