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Ali Alichi, Mr. Ippei Shibata, and Kadir Tanyeri
Government debt in many small states has risen beyond sustainable levels and some governments are considering fiscal consolidation. This paper estimates fiscal policy multipliers for small states using two distinct models: an empirical forecast error model with data from 23 small states across the world; and a Dynamic Stochastic General Equilibrium (DSGE) model calibrated to a hypothetical small state’s economy. The results suggest that fiscal policy using government current primary spending is ineffective, but using government investment is very potent in small states in affecting the level of their GDP over the medium term. These results are robust to different model specifications and characteristics of small states. Inability to affect GDP using current primary spending could be frustrating for policymakers when an expansionary policy is needed, but encouraging at the current juncture when many governments are considering fiscal consolidation. For the short term, however, multipliers for government current primary spending are larger and affected by imports as share of GDP, level of government debt, and position of the economy in the business cycle, among other factors.
Luis-Felipe Zanna, Olivier Basdevant, Ms. Susan S. Yang, Ms. Genevieve Verdier, Mr. Joannes Mongardini, and Dalmacio Benicio

References Box 1. SACU Revenue Sharing Formula Figures 1. Wage Bill in Sub-Saharan Africa, 2005–10 2. Impact of Government Consumption Adjustment for Namibia, in Response to a Decline in SACU Transfers 3. Comparison of the Different Single-Instrument Adjustment Strategies for Namibia 4. Cross-Country Comparison of Different Single-Instrument Fiscal Consolidations and Their Effects on Real GDP 5. GDP Response to Different Policy Instruments 6. Current Account Balance Response to Different Policy Instruments Tables 1. SACU Transfers in BLNS and

International Monetary Fund

that changes in the real exchange rate tend to be passed to the current account over a three year period. 9 The adjustments made in Lee et al (2008, chapter 3) imply a higher coefficient for the productivity differential and a lower (actually zero) coefficient for the impact of government consumption. 10 This analytical issue was pointed out by the Estonian authorities in the technical discussions.

International Monetary Fund

restraint, the general government primary balance at constant oil prices has strengthened by more than 2 percent of GDP since 1999. The impact of government consumption on growth thus declined to -0.1 percentage points in the first half of 2001 from 0.6 percentage points in 1998. 10. After a sharp contraction in 1998, real private consumption has increased steadily in line with real wages . Two factors explain the robust growth of private consumption: a fast increase of reported real wages since late 1999 (real wages are the main component of real income though real

Mr. Giovanni Ganelli

) , which implies that the academic debate on the macroeconomic effects of fiscal policy refers almost exclusively to the impact of government consumption. Since the “new open economy macroeconomics” framework is emerging as the new paradigm for the analysis of macroeconomic interdependence, our contribution offers some insights on the effects of public spending composition in this new framework. We have shown that a reduction in domestic employment used to reduce the tax burden implies both, an immediate increase in domestic consumption compared with foreign consumption

Mr. Giovanni Ganelli
This paper helps resolve a paradox in the literature, noticed by Alesina and Perotti (1995), which is that, although government employment is an important component of public spending, the debate on the effects of fiscal policy focuses almost exclusively on shocks to non-wage government consumption. We incorporate the distinction between spending for government employment and spending for non-wage government consumption in a "new open economy macroeconomics" model. Our results show that a permanent reduction in public employment in one country reduces relative private consumption and appreciates the domestic exchange rate if it is matched by a reduction in taxes. When the reduction in public employment is used to finance increased non-wage government consumption, the macroeconomic effects results are ambiguous, and are affected by the initial level of the public wage bill.
International Monetary Fund
This paper evaluates a fiscal scenario based on the assumption of a rapid scaling-up of expenditure to be followed by a rapid scaling-down in the context of Azerbaijan's current temporary oil production boom. To this end, it relies on a review of historical precedents and a neoclassical growth model. Based on both strands of analysis, the paper suggests that the evaluated fiscal scenario poses significant risks to growth sustainability.