A (Un)Pleasant Arithmetic of Fiscal Policy: the Case of Italian Public Debt

Transcription

1 A (Un)Pleasan Arihmeic of Fiscal Policy: he Case of Ialian Public Deb Luigi Marain * Massimiliano Marzo (Universiy of Bologna) (Universiy of Bologna) January 2008 Absrac Using he simple arihmeic of governmen budge consrain, we perform an analysis on he Ialian case, invesigaing he consequences on he main public finance aggregaes of he adopion of a fiscal policy rule responding o pas real deb/gdp raio. Such a rule, firmly grounded in he economic analysis, would allow he reducion of Ialy's ousanding sock of deb wihou requiring he sric adherence o he 3% crierion for defici/gdp raio, as prescribed by SGP. We perform a forecasing exercise under five alernaive scenarios, analyze he deails of a srucural deb reducion sraegy wih alernaive yearly sep, and finally carry ou a counerfacual exercise by applying our proposed rule o he period JEL classificaion:e61, E62, H63 Keywords: fiscal consolidaion, public deb reducion, fiscal policy. * luigi.marain@unibo.i Diparimeno di Scienze Economiche Srada Maggiore 45- Bologna (Ialy) massimiliano.marzo@unibo.i Facolà di Economia P.zza Scaravilli 2 Bologna (Ialy). Tel:

2 1. Inroducion Since he early Nineies, mos wesern economies had o underake various processes of fiscal consolidaion, aimed a reducing boh public deb and deficis and achieve more solid fiscal posiions. For EU economies, his pah ook he form of he run-up o he Euro (pre-1998) and he sruggle o comply o he Sabiliy and Growh Pac (before and afer he 2005 reform), which governs he necessary coordinaion of Member Saes' fiscal policies afer he esablishmen of he European Moneary Union. Episodes of fiscal consolidaions have been ofen sudied in he economic lieraure. In one of he mos comprehensive of hese sudies, Alesina and Peroi (1997) examine a full sample of OECD counries (and hen focus on Denmark, Ireland and Ialy), and find ha adjusmens relying on governmen expendiure cus had a beer chance of being successful and expansionary; on he oher hand, if hey are based on ax increases and cus in public invesmens, end no o be non-persisen and conracionary. However, he policy debae on he issue is sill far from reaching a widespread consensus on he public finance objecives ha are mos suied o modern economies, and on he sraegies o achieve hem. There is indeed consensus on he need o reduce deb/gdp raios, as an excessive accumulaion of governmen liabiliies pus upward pressures on ineres and inflaion raes, crowds-ou privae spending and employs oo many resources o deb service paymens; such a requiremen is even more binding in a moneary union, in order o preven spillover effecs. Noneheless, he policy debae sill seem o devoe he bes aenion on defici/gdp raios: in paricular, EMU public finance crieria prevens member saes o exceed he 3% ceiling in ha respec. The reform of he SGP, in March 2005, confirms his parameer, alhough emphasizing he imporance of he whole deb reducion sraegy. This paper carries ou a simple bu meaningful exercise: based on he simple arihmeic of public finance, we assume he exisence of a fiscal policy rule in which fiscal pressure responds o pas 2

3 real deb/gdp raio; we disinguish beween ax revenue no immediaely responding o macroeconomic variables ("independen axaion") and ax revenue which is promply available o policy-makers o be manoeuvred in response o, in our case, accumulaion of governmen liabiliies. In his second group we adop he sric definiion of "fiscal pressure", ha is he sum of direc and indirec axaion; we chose o pu social conribuions ino independen axaion, since governmens end o manoeuvre his source of revenue mainly in reference o susainabiliy of pensions sysems, raher han macroeconomic sabilizaion. We calibrae he resuling deb dynamics equaion wih 2007 daa, and perform a number of simulaion regarding he evoluion of public finance aggregaes, under alernaive macroeconomic scenarios, for he period We also carry ou a counerfacual exercise, applying our feedback fiscal rule o he period , o analyze wha would have happened if he governmen had followed explicily a kind of fiscal rule such as he one we propose. The whole analysis is argeed a he ialian case, given he ousanding sock of public deb, which make Ialy he only naion in Europe (and one of he few in he world) wih a deb/gdp raio above he 100% hreshold. The remaining of he paper is organized as follows: secion 2 ses he simple framework and he proposed fiscal rule, briefly discussing he relaed heoreical issues, while secion 3 calibraes he model wih he laes official daa available. Secion 4 proceeds wih he simulaions, divided in hree differen seps: he shor-erm evoluion of public finance aggregaes according o he fiscal policy parameer chosen, he medium-long erm evoluion under five alernaive macroeconomic scenarios, and he discussion on alernaive deb reducion sraegy (feaured by a yearly sep of, respecively, 1% and 2%) using our proposed fiscal rule. Secion 5 performs a counerfacual exercise, applying our fiscal rule o he period and comparing acual deb/gdp and defici / GDP series wih simulaed ones. Secion 6 concludes, discusses some policy implicaions and possible fuure exensions. 3

4 2. The framework:deb/gdp dynamics and fiscal rule The basic dynamic of public deb is: B 1 i B 1 P G T (1) where: B, 1 = sock of nominal public deb i = nominal ineres rae P G T = primary defici in nominal erms Few simple algebraic seps (o be found in he Appendix) leads o he following: where: b i i, 1 real public deb/gdp raio g = rae of growh of real GDP a ime rae of inflaion a ime b b 1 i g b 1 G T Y (2) G T Y primary defici / GDP raio Rearranging he erms: T G Y i g b 1 Δb (3) where Δb is he desired deb/gdp reducion a he end of ime and i is defined as: Δb b b 1 (4) 4

5 Lieraure on fiscal policy has always based is consideraions on he analysis of governmen ineremporal budge consrain: B P E j T j G j j 0 (5) Equaion (5) simply saes ha he sock of real deb a ime mus be equal o he curren value of fuure primary surpluses. Differen opinions on he naure of ha relaionship gave rise o wo alernaive heories of price level deerminaion. In fac, if we inerpre (5) as a consrain given he price level P, i implies ha he governmen is obliged o generae curren or fuure primary surpluses in case i looses conrol on he evoluion of public deb; under his heory, P is enirely deermined by he moneary policy auhoriy, according o he sandard predicion of he Quaniaive Theory of Money. If, insead, we view (5) as an equilibrium relaionship ha has o hold under any circumsances, i means ha if nominal deb increases, primary surpluses do no necessarily have o change accordingly: adjusmen migh occur via change in he price level, so o guaranee he fulfilmen of he equilibrium relaionship. Thus, fiscal indiscipline can cause a movemen in P ; no surprisingly, his simple inerpreaion gave rise in he 90s o he Fiscal Theory of he Price Level (Sims 1994, Cochrane 2001, Woodford 2001 and many ohers), arguing ha price level deerminaion is no necessarily a merely moneary issue. Emphasizing he inflaionary pressures implied by accumulaion of excessive public deb, he Fiscal Theory of he Price Level is, a leas parially, a he hear of he heoreical jusificaions of he public finance requiremens for he European Moneary inegraion process. As firs showed by Leeper 1991, he kind commimen for governmen, implied by he above consideraions, can be achieved by he inroducion of a fiscal rule such as: 5

6 T T 0 B 1 P (6) wih 0 1 being he elasiciy of (lump-sum) axaion o he pas sock of real public deb, and T 0 being ha componen of ax revenue which moves independenly from deb dynamics. Wih such a rule, governmen adjus fiscal pressure so o respond o accumulaion of pas nominal liabiliies deflaed a he curren price level. In he Leeper's erminology, such a rule depics a "passive" policy, as he fiscal auhoriy is no free o choose a decision rule ha depends on curren or expeced fuure variables, bu has o passively adjus direc axes in order o balance he budge, being consrained by he acive auhoriy (he moneary policy one) and, in microfounded frameworks, by consumers opimizaion. Under assumpion of acive moneary policy (responding more han proporionally o an increase in inflaion) as i seems widely esablished in modern economies, Leeper derives he condiions for equilibrium deerminacy wih regard o he fiscal policy rule, which implies he parameer lying in he following range: (7) where is he ineremporal rae of preferences by which consumers discoun uiliy in he nex period and ha is equal, in dynamic general equilibrium models, o he seady-sae real ineres rae. As he value commonly acceped in he lieraure for ranges from 0.95 o 0.99 (corresponding, respecively, o a real ne ineres rae ranging from 5.26% o 1.01%), we see ha he range of values of consisen wih deerminacy is very wide o ensure ha wih a fiscal rule such as (6), here is no risk of an explosive pah for he price level even in he presence of a nominal deb shock, since he feedback 6

7 rule ensures ha he governmen will modify fiscal pressure so o keep consan he value of real deb. Therefore, his kind of fiscal rule is he one mos suied o arge a specific sraegy of public deb reducion, while preserving price sabiliy. On he basis of his heoreical background, we borrow he above fiscal rule and verify is usage in a deb-reducion sraegy based on he Ialian case. Equaion (6) can be modified so as o accoun for measures relaive o GDP, as we did in (2). T Y T 0 Y B 1 P Y T Y T 0 Y B 1 P 1 Y 1 P 1 P Y 1 Y T Y T 0 Y b 1 1 g (8) (8) is a fiscal rule which makes he fiscal pressure a ime (measured by he amoun of oal ax revenue relaive o GDP) responding o he pas real deb/gdp raio, deflaed by he curren inflaion rae and real GDP growh. Insering he fiscal rule (8) ino he deb/gdp dynamics (equaion 2), we obain: b b 1 G Y i g b 1 T 0 Y b 1 1 g b G Y T 0 Y 1 i g 1 g b 1 (9) 7

8 3. Daa and calibraion In order o calibrae he simple model, we use daa from he Noa di aggiornameno al DPEF per gli anni , he main policy paper ha Ialian governmen uilizes in order o define he public finance ineremporal framework. Daa refer o year Laes news anicipaion abou Ialy's public finance (o be officially released a he end of march 2008) give beer resuls on 2007; neverheless, we sick o he laes official news available. Furhermore, we have o consider ha our exercise aim a providing some general and useful insighs, more han represening a proper forecasing exercise; he analysis can easily be updaed along wih he release of new daa. TABLE 1 deb service / GDP i2007b % Y2007 deb/gdp B % Y2006 primary governmen expendiure /GDP G % Y2007 ax revenue / GDP T % Y2007 independen axaion / GDP T0 Y % ECB euro-wide nominal ineres rae i 4% GDP real growh g % inflaion π % Obviously ineres rae on governmen deb does no exacly corresponds o he level of shor-erm ineres rae, which in he euro area is se by he European Cenral Bank; in order o pin down he effecive measure, we divide he deb service by he sock of public deb wih respec o he GDP: 8

9 B i % Y 2006 i % 4.82% i % We obain an average implici ineres rae of 4.51%, which is consisen wih an official ECB rae of 4%, augmened by a small spread. I is imporan o sress ha daa for T 2007 Y 2007 include all ax revenue (direc and indirec axaion, social conribuions and oher ypes of revenues), whereas T 2007 T 0 Y 2007 is he proper definiion of fiscal pressure 1, and i is he componen who respons o public deb movemens. Le us calibrae he fiscal policy parameer according o our fiscal rule (equaion 8): Ialian governmen fiscal sance for he year 2007 implied, herefore, ha ax revenue/gdp raio response o increases in he sock of public deb over GDP is equal o Simulaions 4.1. The evoluion of public finance aggregaes a he end of ime Using daa from previous secion, we now use equaion (9) in order o calculae he possible evoluion of public deb, and oher fiscal policy aggregaes, a he end of ime as a funcion of he parameer (elasiciy of ax revenue o deb/gdp raio). We also disinguish he 2007 (calibraed as above) 1 We calibraed i so o include only direc and indirec axaion, since social conribuions are increasingly mean o respond o susainabiliy of pensions sysems raher han public deb evoluion. 9

10 and he sab, he value of ha sabilizes he deb/gdp raio a he same level as All he experimens are carried ou under he assumpion ha public expendiure's share of GDP is kep consan a he 2006 level. Here is he figure picuring he evoluion of he fiscal variables: FIGURE 1 primary defici /gdp deb/gdp DEBT DEFICIT fi PRIMARY DEFICIT fi defici/gdp deb service /gdp fi DEBT SERVICE fi ax revenue / gdp TAX REVENUE fi The following able shows he corresponding quaniaive values as we pick, alernaively, he fiscal policy parameer calibraed as in 2007 ( ) or he value ha sabilizes he deb/gdp raio a he 2006 level ( sab ). 10

11 φ B2007 TABLE T2007 T2007 D2007 G i2007b2006 Y2007 Y2007 Y2007 Y2007 Y2007 φ = % 2.41% -2.41% 46.60% 4.74% 2007 φ = % 4.05% -0.76% 44.95% 4.82% sab No surprisingly, given our calibraion procedure, he firs line pins down exacly he predicions of Ialian governmen for he year The second line shows he behaviour of main fiscal aggregaes if he governmen adops a sraegy of deb/gdp sabilizaion; as we see, he ceiling of 3% for he defici /GDP raio would be violaed by a considerable exen Evoluion of fiscal variables over ime We now carry ou a simple exercise regarding he evoluion of fiscal policy variables over ime from he year 2008 onwards, under given values of oher macroeconomic variables. In paricular, we analyse he following scenarios: TABLE 3 BASELINE SCEN. 1 SCEN. 2 SCEN.3 SCEN.4 SCEN.5 φ = φ = φ = φ = φ =0.30 φ =0.30 G Y =44.19% G Y =44.19% G Y =44.19% G Y gradual cu G Y =44.19% G gradual cu T0 Y =17.10% T0 Y =17.10% T0 Y =17.10% T0 Y =17.10% T0 Y =17.10% T0 Y =17.10% π =1.9% ECB i =4% π =2.4% ECB i =5% π =1.5% ECB i =3% π =1.9% ECB i =4% π =1.9% ECB i =4% π =1.9% ECB i =4% g =1.9% g =1.1% g =2.5% g =1.9% g =1.9% g =1.9% 11

12 Scenario 1 depics "bad" macroeconomic condiions, wih he rae of growh falling slighly above 1%, inflaion acceleraing o 2.4%, and igh credi condiions (nominal ineres rae a 5%). Conversely, scenario 2 depics "good" macroeconomic environmen, wih low inflaion and ineres rae, and real growh in line (or slighly above) poenial. The firs wo scenarios are analyzed under given fiscal policy sance (same public expendiure/gdp raio and same feedback parameer). Scenario 3 comes back o "medium" macro condiions, bu wih a reducion of (primary) public expendiure of 1% per annum, for four years (so o reach he value of 40.19% of GDP); scenario 4 uses a sronger feedback response o pas deb/gdp raio ( =0.30), whereas scenario 5 is a mix of scenarios 3 and 4, hereby represening he more rigid fiscal scenario. The nex wo subsecions look a he evoluion of he main fiscal aggregaes under he five alernaive scenarios, from 2008 o 2026 and, on he oher hand, analyze he consequences of precise deb reducion sraegies wih, alernaively, a 1% and 2% yearly reducion sep The pah o The following able depics he evoluion of fiscal aggregaes under he alernaive scenarios. Here is he deb/gdp raio: FIGURE 2 12

13 DEBT/GDP RATIO base scen1 scen2 scen3 scen4 scen Under baseline scenario (ha is, ),deb reducion is quie slow, and converges o a level slighly above 100% of GDP. Bad (scenario 1) and good (scenario 2) macro condiions, respecively, worsen and improve he deb reducion rajecory, keeping consan he fiscal sance. Scenario 4 ( 0.30 ) produces almos exacly he same rajecory as scenario 2, meaning ha increasing he response of ax revenue o las year deb/gdp o he level of 0.30 can subsiue for adverse macroeconomic condiions. The bes resuls are achieved under scenarios 3 and 5, depicing a 1% per year reducion of primary public expendiure from 2008 o 2012; scenario 5 achieves bes resuls, iniially, because i implies a sronger response o las year deb. The evoluion of defici / GDP raio is ineresing: 13

14 FIGURE base scen1 scen2 scen3 scen4 scen Under baseline and scenario 1, i increases seadily unil i reaches (respecively), 3.82% and 3.69%. The reason is ha since ax revenue is proporional o he deb/gdp raio, as he laer decreases, he former decreases accordingly; since public expendiure is kep consan, defici increases over ime. Beer macroeconomic condiions (scenario 2) make he defici reducion sronger iniially, and we have confirmaion ha scenarios 2 and 4 produce prey much he same dynamics (alhough he convergence level are slighly differen). Reducion of public expendiure (scenario 3 and 5) produce he bes resuls, bu if hey are no accompanied by an increase in (scenario 3) hey disappear in he long-run, ending up wih he highes defici/gdp level in The reason is ha he permanen reducion of G by four poins speeds up deb reducion, as we observed in Figure 2; his, under a fiscal feedback rule such as (8), decreases ax revenue by a greaer amoun, and hus, once G is sabilized a 40.16%, sars off he defici upurn, which can be kep under conrol only if we increase 14

15 permanenly he response of axaion o deb ( 0.30). I is noeworhy ha all he scenarios involve, in he long-run, a breaking of he 3% ceiling, even in presence of a (more or less pronounced) deb/gdp reducion. The dynamic of fiscal pressure confirms he above resuls: FIGURE base s1 s2 s3 s4 s The srong reducion of ax revenue/gdp raio under scenarios 3 and 5 (hose feaured by greaer deb reducion), is he main responsible for he upraising of defici. The feedback rule, however, leads o a reducion of fiscal pressure in all cases. Deb service is reduced according o he downurn of deb/gdp raio. We observe he big difference ha an increase (scenario 1) or decrease (scenario 2) of 1% in he ECB ineres rae can make for public 15

16 finance. FIGURE base s1 s2 s3 s4 s Variable seps of deb/gdp reducion So far we have se differen macroeconomic condiions (including he fiscal policy sance) and we have observed how deb reducion proceeds in ime. In his secion we go he oher way round: se differen objecives of yearly deb reducion (under he firs four scenarios), and see wha fiscal policy parameer is needed in order o achieve ha objecive. Manipulaing equaion (9), in fac: T 0 Y b 1 1 g G Y i g b 1 Δb i g b 1 Δb G Y T 0 Y 1 g b 1 16

17 wih Δb being he deb reducion sep ( b b 1 ). We see wha happens if he governmen chooses o adop a (more or less) drasic sraegy of deb reducion, bringing down deb/gdp raio by a consan amoun each year. We only analyze he firs hree scenarios, as 4 and 5 differ exacly because hey fix a new (and given) level for. Here are he resuls for, respecively, Δb 1%, which would allow deb/gdp raio o be below he 100% hreshold by 2013, and o reach 97.15% in FIGURE FI base s1 s2 s DEFICIT / GDP TAX REVENUE / GDP 0.06 DEBT SERVICE / GDP Afer he small decrease in 2008, he feedback parameer required o suppor a 1% yearly reducion of deb/gdp, increases over ime, as i has o compensae he reducion in he sock of public deb. A permanen, alhough gradual, reducion in public expendiure (scenario 3) would allow o be on a 17

18 decreasing pah, a leas unil 2011 (a he same ime, ax revenue/gdp can also decrease subsanially). Afer an increase in 2008, defici shows a decreasing pah, wih an ineresing feaure: baseline and scenario 3 overlap almos perfecly. In oher words, if public expendiure is no permanenly decreases, he dynamics of defici is he same since he higher value of he parameer compensaes; however, as shown in he lower-lef panel, ax pressure would be higher. If he deb reducion sraegy adops a 2% sep per year, he raio reaches 89.15% by 2015, and he behaviour of fiscal variables is: FIGURE base s1 s2 s3 FI DEFICIT/GDP TAX REVENUE/GDP 0.06 DEBT SERVICE/GDP We can observe he same pah as above, wih he only difference being he quaniaive effecs, which are obviously sronger in his case. Tax pressure is he same, since he quicker reducion of deb/gdp raio is compensaed by he higher fiscal parameer. 18

19 5. A counerfacual applicaion The wo previous secions were concerned wih predicions on he evoluion of fiscal variables under differen hypohesis and scenarios, assuming ha he governmen explicily adoped a fiscal rule such as equaion (6). Here we ask ourselves wha would have happened if such a fiscal policy rule had been applied in Ialy in he las decade. We calibrae equaion (9) using daa from he ime span Firs we pin down he implici parameer on he basis of he acual deb dynamics occurred in ha period; hen we obain simulaed deb/gdp and defici/gdp series, analyzing wha would have happened had he governmen adoped explicily our fiscal rule, wih given and alernaive values for he feedback parameer. Here is he able of daa: TABLE G 42.9% 41.7% 41.4% 41.3% 41.3% 41.7% T Y 45.1% 45.6% 45.8% 48% 46.5% 46.7% T % 16.46% 17.93% 18.54% 16.15% 16.21% i 9.65% 9.21% 9.25% 7.64% 6.63% 5.75% π 3.48% 5.03% 5.28% 2.39% 2.71% 1.57% g 2.2% 2.9% 0.7% 1.9% 1.4% 1.9% ib 11.4% 11.5% 11.5% 9.4% 8% 6.7% Y G T + ib 9.3% 7.6% 7.1% 2.7% 2.8% 1.7% Y b -6.7% 0.5% 1.2% 2.5% 4% 1% G Y % 41.8% 41.9% 43.4% 43.3% 43.9% 45.9% 19

20 T Y 45.8% 45% 44.5% 45.1% 44.6% 44.4% 46.9% T % 16.11% 16.25% 16.43% 16.65% 16.79% 16.8% i 5.62% 5.84% 5.23% 4.89% 4.89% 4.34% 4.3% π 2.19% 2.65% 3.06% 2.94% 2.62% 2% 2.2% g 3.6% 1.8% 0.3% 0 1.1% 0 1.9% ib 6.5% 6.5% 5.8% 5.3% 5.1% 4.5% 4.58% Y G T + ib 1.9% 3.1% 2.9% 3.4% 3.4% 4.1% 4.4% Y b 4.3% 0.4% 2.6% 4.1% 0.4% -2.6% -0.4% Implici ineres raes have been calculaed using he same procedure as in he previous secion (i.e. dividing he overall deb service expendiure by he exising sock of public deb). Nex we show he figure of he resuling implici from 1994 o 2006 (quaniaive daa o be found in Appendix B): FIGURE 8 20

21 0.32 EVOLUTION OF DEBT-SENSITIVITY FROM 1994 TO FI YEAR Visual inspecion of Figure 8 is a good way o assess Ialian governmen's fiscal sance. Sensiiviy of (direc and indirec) axaion o real deb/gdp raio shows an increasing rend over he years, confirming he arising of he need of fiscal consolidaion. In paricular, we noe wo peaks: in , corresponding o he run-up o he Maasrich crieria, and in 2003, wih he approaching of he Excessive Defici Procedure for breaking he Sabiliy and Growh Pac parameer. The following exercises show wha he deb and defici dynamics would have been, had he governmen adoped, respecively, (he mean over he ime span), 0.28, Simulaed series are compared wih he acual ones (quaniaive resuls in Appendix B). FIGURE 9 21

22 ALTERNATIVE DEBT TRAJECTORIES FROM 1994 TO 2006 fi= fi=0.28 fi=0.30 acual FIGURE ALTERNATIVE DEFICIT TRAJECTORIES FROM 1994 TO 2006 fi= fi=0.28 fi=0.30 acual

23 Figure 9 shows ha adoping an explici fiscal rule such as (6) would have ensured a seadier reducion of deb/gdp raio unil 2002, wih an uprising henceforh. Neverheless, final resuls in 2006 would have been, sensibly, improved only adoping a Wih he average value ( ), in fac, resuls would have been worse, whereas wih 0.28 he final poin would have been prey much he same. I is noeworhy remember, however, ha over he enire ime span he disance beween he acual and he simulaed series is srongly in favour of he laer. Figure 10 shows ha if he alernaives deb reducions sraegies had been pu in place, he corresponding defici/gdp raios would have been more ofen above he 3% ceiling ha hey had acually been in realiy. A furher confirmaion ha he adopion of a fiscal policy rule responding o real deb/gdp raio can manage o implemen a successful reducion sraegy wihou having o "ie he hands" o a given numerical parameer for defici/gdp. 6. Conclusions Afer he burs of he "ax and spend" Keynesian bubble, mos indusrialized economies have been faced wih he pressing need of srucural adjusmen of public finance's imbalances. For European naions, his process was mainly governed by he advancemen of he European Union economic inegraion, and he esablishmen of he European Moneary Union a he end of he las decade, which required he compliance wih sric public finance crieria boh before and afer he saring of he single currency. In his overall conex, Ialy's siuaion has been paricularly relevan, as i enered he euro wih a deb/gdp raio wice as much as he average value for admission; afer ha, reducion sraegy has proven o be no as aggressive and deermined as needed, in order o esablish a credible fiscal consolidaion plan. 23

24 In his paper, we ried o invesigae he consequences for Ialian public finance of he adopion of a simple fiscal policy rule, in which he "variable" componen of ax revenue (ha we idenify wih fiscal pressure) responds o he accumulaion of pas real deb/gdp raio, wih an elasiciy given by he crucial feedback parameer. Our resuls show ha he adopion of such a rule could help simplifying he undersanding of he fiscal policy framework, and can be summarized as follows: - from he policy poin of view, a significan deb reducion can occur if he feedback response is slighly increased wih respec o he recen endency (up unil 0.30 ) or if primary governmen expendiure is gradually reduced by four percenage poins over he nex four years. Beer resuls, obviously, are achieved if he wo above acions are aken joinly. Deerioraion of general macroeconomic condiions (in paricular, a rise in deb service) can significanly worsen he scenario. - under given condiions, susained deb reducion can be achieved also wih a defici/gdp raio greaer han 3% (he SGP parameer). The basic inuiion is he following: if he ax revenue is permanenly se o respond o public deb, he iniial susained reducion of he laer will cause a reducion of he former. The consequen negaive effecs on defici are however parially compensaed by he reducion in he deb service, bu sill preven defici/gdp raio o be permanenly reduced. A he same ime, fiscal pressure can be se on a decreasing pah. - a consisen sraegy of yearly one (wo) per cen reducion of deb/gdp raio would allow i o be a 97.15% (89.15%) by 2015, bu i would require a consan increase in he feedback parameer. Noneheless, fiscal pressure would remain seady, and defici/gdp raio would be under conrol. - given all macroeconomic variables, if a fiscal rule such as he one we pu forward was adoped in Ialy from 1994, deb/gdp reducion would have been seady and smooh, alhough in he las couple of years more aggressive measure would have been needed. Tha resul could have been achieved even in presence of repeaed violaion of he 3% ceiling for he defici/gdp raio. This paper does no include any srucural analysis, nor microfoundaions. I is a fairly simple 24

25 compuaional exercise showing he benefis of he adopion of a fiscal rule responding o deb/gdp accumulaion. However, we believe i can be a conribuion o he undersanding of he real policy acion needed in order o achieve a susainable fiscal posiion and, a he same ime, alleviae ax pressure on economic agens. Fuure research in his field can include he exensions of he comparaive analysis a he EMU level, and a greaer effor o srenghen he policy forecas of fully-microfounded models. References Alesina, A., Peroi, R. (1997), "Fiscal Adjusmens in OECD Counries: Composiion and Macroeconomic Effecs" IMF Saff Papers, June 1997, 44: Cochrane,J.H.,(2001), "Long-Term Deb and Opimal Policy in he Fiscal Theory of he Price Level" Economerica,69 (1), Leeper, E.M., (2001), "Equilibria Under "Acive" and "Passive" Moneary and Fiscal Policy" Journal of Moneary Economics 27: Sims,C.A., (1994), "A Simple Model for he Sudy and he Deerminaion of he Price Level and he Ineracion of Moneary and Fiscal Policy" Economic Theory 4: Woodford, M. (2001), "Fiscal Requiremens for Price Sabiliy" Journal of Money, Credi and Banking 33: Appendix A: Derivaions 25

26 Derivaions of he dynamic of real deb/gdp raio Sar from equaion (1): B 1 i B 1 P G T Divide boh sides by he curren real GDP ( P Y ): B P Y 1 i B 1 P Y G T Y (A1) which can be seen as: B P Y B 1 P 1 i 1 P 1 Y 1 P Y 1 Y G T Y (A2) I is also well known ha: P 1 P 1 1 Y 1 Y 1 1 g where: = rae of inflaion a ime g = rae of growh of real GDP a ime Plugging hose expression is (A2): b 1 i 1 1 g b 1 G T Y (A3) where b, 1 real deb/gdp raio Exploiing he well-known approximaions: 26

27 1 1 g 1 g 1 i 1 g 1 i g we ge o equaion (1): Appendix B: Oher Tables Table B1 Baseline scenario b b 1 i g b 1 G T Y Evoluion of fiscal variables over ime YEAR B D T G T ib % 2.41% 46.60% -2.41% 4.82% % 2.79% 46.14% -1.95% 4.74% % 3.07% 45.81% -1.62% 4.69% % 3.15% 45.57% -1.38% 4.65% % 3.42% 45.39% -1.20% 4.62% % 3.61% 45.16% -0.97% 4.60% % 3.67% 45.09% -0.90% 4.56% % 3.71% 45.04% -0.85% 4.56% % 3.74% 45% -0.81% 4.56% % 3.76% 44.98% -0.79% 4.55% % 3.78% 44.96% -0.77% 4.55% % 3.79% 44.94% -0.75% 4.55% % 3.80% 44.93% -0.74% 4.54% % 3.81% 44.92% -0.73% 4.54% % 3.81% 44.92% -0.73% 4.54% % 3.82% 44.92% -0.73% 4.54% % 3.82% 44.91% -0.72% 4.54% % 3.82% 44.91% -0.72% 4.54% % 3.82% 44.91% -0.72% 4.54% % 3.82% 44.91% -0.72% 4.54% 27

28 Table B2: Scenario 1 YEAR B D T G T ib % 2.41% 46.60% -2.41% 4.82% % 3.76% 46.23% -2.04% 5.79% % 3.74% 46.25% -2.06% 5.80% % 3.73% 46.26% -2.07% 5.80% % 3.72% 46.28% -2.09% 5.80% % 3.71% 46.28% -2.09% 5.81% % 3.71% 46.29% -2.10% 5.81% % 3.70% 46.30% -2.11% 5.81% % 3.70% 46.30% -2.11% 5.81% % 3.70% 46.30% -2.11% 5.81% % 3.69% 46.30% -2.11% 5.81% % 3.69% 46.31% -2.12% 5.81% % 3.69% 46.31% -2.12% 5.81% % 3.69% 46.31% -2.12% 5.81% % 3.69% 46.31% -2.12% 5.81% % 3.69% 46.31% -2.12% 5.81% % 3.69% 46.31% -2.12% 5.81% % 3.69% 46.31% -2.12% 5.81% % 3.69% 46.31% -2.12% 5.81% % 3.69% 46.31% -2.12% 5.81% Table B3: Scenario 2 YEAR B D T G T ib % 2.41% 46.60% -2.41% 4.82% % 1.79% 46.09% -1.90% 3.69% % 2.37% 45.42% -1.23% 3.61% % 2.79% 44.94% -0.75% 3.55% % 3.09% 44.60% -0.41% 3.50% % 3.31% 44.35% -0.16% 3.47% % 3.46% 44.17% 0.02% 3.45% % 3.58% 44.05% 0.14% 3.43% % 3.66% 43.95% 0.24% 3.42% % 3.71% 43.89% 0.30% 3.41% % 3.76% 43.84% 0.35% 3.40% % 3.79% 43.80% 0.39% 3.40% % 3.81% 43.78% 0.41% 3.40% % 3.82% 43.76% 0.43% 3.39% % 3.83% 43.75% 0.44% 3.39% % 3.84% 43.74% 0.45% 3.39% 28

29 % 3.85% 43.73% 0.46% 3.39% % 3.85% 43.73% 0.46% 3.39% % 3.85% 43.72% 0.46% 3.39% % 3.86% 43.72% 0.47% 3.39% Table B4: Scenario 3 YEAR B D T G T ib % 2.41% 46.60% -2.41% 4.82% % 1.79% 46.14% -2.95% 4.74% % 1.30% 45.53% -3.34% 4.64% % 0.9% 44.81% -3.62% 4.52% % 0.58% 44.01% -3.82% 4.39% % 1.30% 43.14% -2.95% 4.25% % 2.11% 42.18% -1.99% 4.09% % 2.69% 41.49% -1.30% 3.98% % 3.10% 40.99% -0.80% 3.90% % 3.40% 40.63% -0.44% 3.84% % 3.62% 40.38% -0.19% 3.80% % 3.77% 40.19% 0% 3.77% % 3.88% 40.06% 0.13% 3.75% % 3.96% 39.96% 0.23% 3.73% % 4.02% 39.90% 0.29% 3.72% % 4.06% 39.85% 0.34% 3.71% % 4.09% 39.81% 0.38% 3.71% % 4.11% 39.79% 0.40% 3.70% % 4.12% 39.77% 0.42% 3.70% % 4.13% 39.76% 0.43% 3.70% 29

30 Table B5: Scenario 4 YEAR B D T G T ib % 2.41% 46.60% -2.41% 4.82% % 1.44% 47.49% -3.30% 4.74% % 2.06% 46.75% -2.56% 4.63% % 2.51% 46.22% -2.03% 4.54% % 2.83% 45.84% -1.38% 4.49% % 3.06% 45.57% -1.18% 4.44% % 3.23% 45.37% -1.04% 4.41% % 3.35% 45.23% -0.94% 4.39% % 3.43% 45.13% -0.87% 4.37% % 3.50% 45.06% -0.82% 4.36% % 3.54% 44.01% -0.78% 4.35% % 3.57% 44.97% -0.75% 4.35% % 3.59% 44.94% -0.73% 4.34% % 3.61% 44.92% -0.72% 4.34% % 3.62% 44.91% -0.71% 4.34% % 3.63% 44.90% -0.70% 4.34% % 3.64% 44.89% -0.70% 4.34% % 3.64% 44.89% -0.69% 4.34% % 3.64% 44.88% -0.69% 4.33% % 3.65% 44.88% -0.69% 4.33% Table B6: Scenario 5 YEAR B D T G T ib % 2.41% 46.60% -2.41% 4.82% % 0.44% 47.49% -4.30% 4.74% % 0.31% 46.46% -4.27% 4.58% % 0.17% 45.44% -4.25% 4.42% % 0% 44.41% -4.22% 4.26% % 0.91% 43.39% -3.20% 4.10% % 1.53% 42.65% -2.46% 3.99% % 1.97% 42.12% -1.93% 3.90% % 2.30% 41.74% -1.55% 3.84% % 2.53% 41.47% -1.28% 3.80% % 2.69% 41.27% -1.08% 3.77% % 2.81% 41.13% -0.94% 3.75% % 2.90% 41.03% -0.84% 3.73% % 2.96% 40.96% -0.77% 3.72% % 3% 40.90% -0.71% 3.71% 30

31 % 3.03% 40.87% -0.68% 3.71% % 3.05% 40.84% -0.65% 3.70% % 3.07% 40.82% -0.63% 3.70% % 3.08% 40.81% -0.62% 3.70% % 3.09% 40.80% -0.61% 3.70% Table B7 Implici feedback parameer calculaed for YEAR φ Table B8 Acual and simulaed deb/gdp raios YEAR B B Y φ = Y φ = 0.28 Y φ = 0.30 B acual % % % 124.8% % % % 124.3% % % % 123.1% % % % 120.6% % % 99.78% 116.6% % % 98.61% 115.6% % % 95.86% 111.3% % % 95.35% 110.9% % % 95.11% 108.3% % % 96.62% 104.2% % % 96.45% 103.8% % % 96.63% 106.4% % % 98.13% 106.8% B Y 31

32 Table B9 Acual and simulaed defici/gdp raios YEAR D D D Y φ = Y φ = 0.28 Y φ = 0.30 acual % 4.97% 2.73% 9.3% % 5.77% 4.03% 7.6% % 4.08% 2.68% 7.1% % 1.59% 0.52% 2.7% % 3.45% 2.68% 2.8% % 2.87% 2.30% 1.7% % 3.42% 2.96% 1.9% % 4.17% 3.76% 3.1% % 3.30% 2.96% 2.9% % 4.19% 3.90% 3.4% % 3.81% 3.43% 3.4% % 3.24% 2.93% 4.1% % 5.55% 5.46% 4.4% D Y 32

33 33