Fiscal Limits, External Debt, and Fiscal Policy in Developing Countries
IMF Working Papers, March 31, 2014
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- Fiscal Limits, External Debt, and Fiscal Policy in Developing Countries
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Bibliographic details
- Authors: Huixin Bi, Wenyi Shen, Susan S. Yang
- Published: March 31, 2014
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475521665.001
Authors and publication
- By Huixin Bi, Wenyi Shen, Susan S. Yang
- March 31, 2014
Research question and methodology
- Studies fiscal policy effects in developing countries with external debt and sovereign default risks.
- Simulates state-dependent distributions of fiscal limits based on macroeconomic uncertainty and fiscal policy specifications.
- Focus on how expected future revenue, external debt, and exchange-rate-driven devaluation affect sovereign default probabilities and fiscal limits.
Key findings
- 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 because large devaluation of the real exchange rate can suddenly raise default probabilities.
- 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.
- In a high-debt state, as more revenue is required to service debt, higher tax rates raise the economic cost of increasing consumption, reducing the fiscal multiplier.
Policy implications and interpretation
- Policies that rely on fiscal consolidation should account for counterproductive short- and medium-run effects highlighted by the analysis.
- Revenue expectations and measures to stabilize the real exchange rate matter for extending fiscal space in developing countries.
- The effectiveness of government spending as a stimulus is state-dependent; near fiscal limits, spending multipliers are lower due to higher tax distortions.
Keywords and subject areas
- Subject: Expenditure, Fiscal consolidation, Fiscal policy, Government consumption, National accounts, Public debt
- Keywords: debt distribution, debt state, developing countries, Eastern Europe, exchange rate, external debt, Fiscal consolidation, fiscal limits, fiscal policy, fiscal policy effect, Government consumption, government spending, government spending effect, government spending multiplier, government spending share, government spending shock, risk premium, sovereign default risk, state-dependent fiscal multiplier, terms of trade, WP