Sovereign debt crises coincide with deep recessions. I propose a model of sovereign debt that rationalizes large contractions in economic activity via an aggregate-demand amplification mechanism. The mechanism also sheds new light on the response of consumption to sovereign risk, which I document in the context of the Eurozone crisis. By explicitly separating the decisions of households and the government, I examine the interaction between sovereign risk and precautionary savings. When a default is likely, households anticipate its negative consequences and cut consumption for self-insurance reasons. Such shortages in aggregate spending worsen economic conditions through nominal wage rigidities and boost default incentives, restarting the vicious cycle. I calibrate the model to Spain in the 2000s and find that about half of the output contraction is caused by default risk. More generally, sovereign risk exacerbates volatility in consumption over time and across agents, creating large and unequal welfare costs even if default does not materialize.
Ms. Dora Benedek, Ruud A. de Mooij, and Mr. Philippe Wingender
This paper estimates the pass through of VAT changes to consumer prices, using a unique dataset providing disaggregated, monthly data on prices and VAT rates for 17 Eurozone countries over 1999-2013. Pass through is much less than full on average, and differs markedly across types of VAT change. For changes in the standard rate, for instance, final pass through is about 100 percent; for reduced rates it is significantly less, at around 30 percent; and for reclassifications it is essentially zero. We also find: differing dynamics of pass through for durables and non-durables; no significant difference in pass through between rate increases and decreases; signs of non-monotonicity in the relationship between pass through and the breadth of the consumption base affected; and indications of significant anticipation effects together with some evidence of lagged effects in the two years around reform. The results are robust against endogeneity and attenuation bias.
Denmark, Finland, Norway, and Sweden form a tightly integrated region which has strong ties with the euro area as well as some exposure to Russia. Using the IMF’s Global Integrated Monetary and Fiscal model (GIMF), we examine spillovers the region could face, focusing on possible scenarios from the rest of the euro area and Russia, and the fall in global oil prices. We show that the spillovers from these scenarios differ in magnitude and impact, regardless of the high degree of integration among the four Nordic economies. These differences are driven by the fact that Denmark and Finland have no independent monetary policy, and Denmark and Norway are net energy exporters while Finland and Sweden are energy importers. We infer lessons for policy from the outcomes.
This paper develops and estimates a general equilibrium rational expectations model with search and multiple equilibria where aggregate shocks have a permanent effect on the unemployment rate. If agents' wealth decreases, the unemployment rate increases for a potentially indefinite period. This makes unemployment rate dynamics path dependent as in Blanchard and Summers (1987). I argue that this feature explains the persistence of the unemployment rate in the U.S. after the Great Recession and over the entire postwar period.
Mr. Daniel Leigh, Mr. Andrea Pescatori, and Mr. Jaime Guajardo
This paper investigates the short-term effects of fiscal consolidation on economic activity in OECD economies. We examine the historical record, including Budget Speeches and IMFdocuments, to identify changes in fiscal policy motivated by a desire to reduce the budget deficit and not by responding to prospective economic conditions. Using this new dataset, our estimates suggest fiscal consolidation has contractionary effects on private domestic demand and GDP. By contrast, estimates based on conventional measures of the fiscal policy stance used in the literature support the expansionary fiscal contractions hypothesis but appear to be biased toward overstating expansionary effects.
Expenditure in Iceland, especially related to the government wage bill, has tended to move in a procyclical manner, related to the fragmentation of political decision making. Iceland's elevated macroeconomic volatility reinforces these tendencies, as large booms unleash greater fiscal pressures as well as procyclical revenue elasticities that magnify these underlying strains. To improve its fiscal framework, Iceland could look to the experience of countries like Belgium and the Netherlands. In particular, it could adopt binding nominal expenditure rules, independent forecasts, and use representative committees to lay out medium-term targets across different levels of government.
Recent empirical research finds that pairs of countries with stronger trade linkages tend to have more highly correlated business cycles. We assess whether the standard international business cycle framework can replicate this intuitive result. We employ a three-country model with transportation costs. We simulate the effects of increased goods market integration under two asset market structures, complete markets and international financial autarky. Our main finding is that under both asset market structures the model can generate stronger correlations for pairs of countries that trade more, but the increased correlation falls far short of the empirical findings. Even when we control for the fact that most country-pairs are small with respect to the rest of the world, the model continues to fall short. We also conduct additional simulations that allow for increased trade with the third country or increased TFP shock comovement to affect the country pair's business cycle comovement. These simulations are helpful in highlighting channels that could narrow the gap between the empirical findings and the predictions of the model.
The paper discusses a model in which growth is a negative function of fiscal burden. Moreover, growth discontinuously switches from high to low as the fiscal burden reaches a critical level. The paper provides an overview of key elements of corporate bankruptcy codes and practice around the world that are relevant to the debate on sovereign debt restructuring. It also describes the broad trends in international financial integration for a sample of industrial countries and explains the cross-country and time-series variation in the size of international balance sheets.
International Monetary Fund. External Relations Dept.
The longer the U.S. economic expansion persists, the more it seems to puzzle analysts. Is it an instance of a particularly fortunate virtuous cycle—bred of good policy but extended by extraordinary good luck? Or, as is increasingly asked, does it reflect structural, and permanent, changes that may have enduring implications for the U.S. economy and perhaps others?
This paper reviews economic developments in Norway during the 1990s, with an emphasis on developments in 1993 and 1994. The paper covers developments in the real economy, in the public finances, and in the monetary and exchange rate area. The private consumption in Norway remained weak through the first half of 1993 but picked up sharply during the second half of the year, as declining interest rates and rising housing prices boosted consumer confidence. Seasonally adjusted, private consumption rose by 3.5 percent between the first and second halves of 1993.