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International Monetary Fund

Abstract

Reducing the budget deficit is not easy. Keynesian theory suggests thatlowering government expenditures and raising revenues can lead to afalloff in economic activity. This paper argues the neoclassical approach - that a firm and credible reduction in expenditures, by engendering confidence that taxes will be less burdensome in the future,may lead to lower interest rates, boost consumption, and increaseinvestment spending.

Mr. Robert F. Westcott and Mr. C. John McDermott
This study uses the fiscal expansion and consolidation experiences of the industrial countries over the period 1970 to 1995 to examine the interplay between fiscal adjustments and economic performance. A key finding is that fiscal consolidation need not trigger an economic slowdown. Fiscal consolidation that concentrates on the expenditure side, and especially on transfers and government wages, is more likely to succeed in reducing the public debt ratio than tax-based consolidation. Also, the greater the magnitude of the fiscal consolidation, the more likely it is to succeed in reducing the debt ratio.
International Monetary Fund. European Dept.
This Selected Issues paper examines implications of capital account liberalization in Iceland. Capital controls were critical in 2008 to avoid a more severe collapse of the Icelandic economy. Six years later, capital inflows have been liberalized, but most outflows remain restricted. Iceland has used the breathing room to reduce flow and stock vulnerabilities, strengthen institutions, and prepare for the lifting of capital controls. Simulations using the central bank’s Quarterly Macroeconomic Model (QMM) suggest that, compared with the 2008 crisis episode, the economy can better withstand the impact of an abrupt removal of capital controls. However, the outcome would be dependent on a number of factors, including resident depositor behavior.
International Monetary Fund. Research Dept.
This paper reviews recent theoretical and empirical work on controls over International capital movements. Theoretical contributions reviewed focus on “second-best “ arguments for capital market restrictions, as well as arguments based on multiple equilibria. The empirical literature suggests that controls have been “effective “ in the narrow sense of influencing yield differentials. But there is little evidence that controls have helped governments meet policy objectives, with the exception of reducing the governments’ debt-service costs, and no evidence that controls have enhanced economic welfare in a manner suggested by theory.
International Monetary Fund. External Relations Dept.
The Web edition of the IMF Survey is updated several times a week, and contains a wealth of articles about topical policy and economic issues in the news. Access the latest IMF research, read interviews, and listen to podcasts given by top IMF economists on important issues in the global economy. www.imf.org/external/pubs/ft/survey/so/home.aspx
International Monetary Fund. European Dept.

leverage, currency depreciation, and spiking interest rates—contributed to the overall decline (figure). FCI Based on PCA (Standardized index,1994Q1-2014Q2) Sources: Central Bank of Iceland; Statistics Iceland; and IMF Staff calculations. 9. The recovery in financial conditions was impressive in 2010-11 but has stalled since then . A rebound in asset prices, a gradual private-sector deleveraging, a reduction in interest rates, and some currency appreciation lifted the FCI in 2010-11. However, since then, the recovery in financial conditions has stalled

Mr. Robert F. Westcott and Mr. C. John McDermott

different phases of the business cycle. This is achieved by repeating the previous exercise for the period 1980–81, a time of global recession and spiking interest rates, and the period 1984–89, a period of solid industrial country growth and flat or declining world interest rates. Clearly, it is difficult to reduce debt ratios in the midst of a global recession, especially if interest rates are increasing sharply at the same time. 17 None of the 7 efforts at fiscal consolidation over 1980–81, for example, including the highly visible efforts in the United Kingdom, were

International Monetary Fund. External Relations Dept.

, were more likely to succeed in reducing the public debt ratio than tax increases. Global Climate and Fiscal Adjustment . McDermott and Wescott note a discernible relationship between the world economic growth climate and the success of fiscal consolidation efforts. But the size and composition of the adjustment, they say, still seem to be the dominant determinants of the outcome, even when the world economy is booming. For instance, none of the seven consolidation efforts undertaken during 1980–81—a time of global recession and spiking interest rates—was successful

Mr. C. John McDermott and Mr. Robert F. Westcott

analyze this relationship is to examine fiscal adjustments over different phases of the business cycle. This objective is achieved by repeating the previous exercise, which was conducted over the full 1970–95 period, for the period 1980–82, a time of global recession and spiking interest rates, and the period 1984–89, a time of solid industrial country growth and flat or declining world interest rates. Clearly, it is difficult to reduce debt ratios in the midst of a global recession, especially if interest rates are increasing sharply at the same time. 16 None of the 7

International Monetary Fund

efforts. Cause or Effect? Given the complex interactions between economic growth and changes in public debt ratios, it is difficult to distinguish between the contribution of growth to successful fiscal consolidations and the contribution of successful consolidations in boosting growth. One way to analyze this relationship, however, is to examine fiscal adjustments during different phases (recession or expansion) of the business cycle. None of the seven efforts at fiscal consolidation during 1980–81, a period of global recession and spiking interest rates, was