Inernaional Journal of Business and Economics, 2009, Vol. 8, No. 2, 133-158 Public Spending and he Macroeconomy: Evidence from Developing and Developed Counries Magda Kandil * Inernaional Moneary Fund, Wesern Hemisphere Deparmen, U.S.A. Absrac Using annual daa, his paper sudies he ime series evidence regarding he effeciveness of governmen spending. Crowding ou appears more prevalen in he face of variaion in governmen spending in advanced counries. Privae consumpion and inflaion vary more closely wih governmen spending in developing counries. Key words: fiscal simulus; crowding ou; supply consrains; developing and advanced counries JEL classificaion: E61; E62; E63; E32; E21 1. Inroducion In recen years, here has been a lo of discussion abou he role of sabilizaion policies. During a recession, i is possible o simulae he economy hrough expansionary fiscal or moneary policies. The increased demand is likely, in urn, o simulae oupu growh and price inflaion. Conversely, during a boom i is possible o curb excess demand hrough conracionary fiscal or moneary policies. Demand reducion is likely, in urn, o moderae oupu growh and price inflaion. The sabilizing funcion of fiscal policies is dependen on heir effecs on nominal and real variables. The debae concerning he effeciveness of fiscal policies in sabilizing economic condiions is an old opic. Keynesians have argued for he effeciveness of fiscal policy. The effeciveness of moneary policy is likely o depend on condiions in he credi marke and he effec of credi availabiliy on privae spending (Tobin, 1947). The change in governmen spending guaranees imely changes in aggregae demand. Demand and/or supply condiions may differeniae he expansionary and conracionary effecs of fiscal policies. For example, aggregae demand shifs may be differen in he face of expansionary and conracionary governmen spending shocks. Received Ocober 21, 2008, revised Augus 26, 2009, acceped Ocober 10, 2009. * Correspondence o: Inernaional Moneary Fund, Wesern Hemisphere Deparmen, 700 19h Sree NW, Washingon DC 20431, U.S.A. The views in he paper are hose of he auhor and should no be inerpreed as hose of he IMF or IMF policy.
134 Inernaional Journal of Business and Economics An increase in governmen spending increases he demand for goods and oal income. Higher spending may promp he governmen o issue more bonds. If he public perceives governmen bonds as wealh, privae consumpion increases. Alernaively, if consumers are Ricardian, hey are likely o discoun fully fuure ax liabiliies associaed wih higher governmen spending. Moreover, expansionary governmen spending shocks increase he demand for loanable funds and raise he ineres rae, crowding ou privae spending. The behavior of Ricardian consumers and condiions in he credi marke may be differen wih respec o posiive and negaive governmen spending shocks, differeniaing he size of he shifs in aggregae demand. On he supply side, condiions in labor and/or produc markes may differeniae he slope of he supply curve in he face of expansionary and conracionary shocks o governmen spending. If wages and/or prices are more flexible in he upward direcion, compared o he downward direcion, equal size demand shifs will have asymmeric effecs on oupu and price. Given heoreical argumens for sources of demand and/or supply asymmery, previous invesigaions (Kandil, 2001, 2002a) provided evidence of asymmery in he effecs of governmen spending shocks, using daa for ineres raes, oupu, prices, and wages in he US. The presen invesigaion will shed ligh on he ransmission channel of variaion in governmen spending using daa for a sample of developing and advanced counries. The objecive is o shed ligh on he following quesions: How is he fiscal simulus or wihdrawal disribued o componens of aggregae demand? and Is here evidence of co-movemens in componens of aggregae demand wih respec o variaion in governmen spending? The change in governmen spending follows a sochasic rend ha varies wih agens forecass in seady sae. Shocks represen symmeric random flucuaions around agens forecass during periods of expansionary and conracionary fiscal sance. The ime series evidence will indicae he effecs of governmen spending shifs, anicipaed as well as posiive and negaive shocks, on componens of aggregae demand (privae consumpion, privae invesmen, expors, and impors), as well as on real oupu growh and price inflaion. Cross-counry correlaions across he sample of advanced and developing counries will illusrae he allocaion of governmen spending shifs beween componens of aggregae demand, oupu growh, and price inflaion. These allocaions will indicae he degree of price flexibiliy and he elasiciy of aggregae demand wih respec o changes in governmen spending across developing counries, in conras o advanced counries. Underlying hese allocaions is he difference in srucural and insiuional consrains ha characerize he demand and supply channels. Cross-counry analysis will measure variaions in rend and variabiliy of demand componens, oupu growh, and price inflaion wih he variabiliy of governmen spending across he samples of developing and advanced counries. To anicipae he resuls, he evidence illusraes ineresing differences regarding he ineracion beween governmen spending and he macroeconomy
Magda Kandil 135 across developing and advanced counries. Consisen wih liquidiy consrains, crowding ou appears more prevalen in he face of an increase in governmen spending in advanced counries. Privae consumpion varies more closely wih governmen spending in developing counries, increasing inflaionary pressures. Concerns abou crowding ou privae aciviy in advanced counries and fueling inflaion in developing counries demand careful managemen of variaion in governmen spending o reduce uncerainy and limi poenial adverse effecs on economic growh. The remainder of he invesigaion is organized as follows. Secion 2 oulines he heoreical underpinnings of demand and supply-side channels ha deermine he asymmeric effecs of fiscal policies. Secion 3 presens he ime series model. Secion 4 analyzes he difference across advanced and developing counries regarding he asymmeric effecs of fiscal shocks. Secion 5 conrass he implicaions of asymmery across counries. Secion 6 concludes. 2. The Asymmeric Effecs of Governmen Spending This secion oulines he heoreical argumens regarding deerminans of asymmery in he face of variaion in governmen spending. Tradiionally, discreionary fiscal policy aims a deermining aggregae demand by varying he level of public spending. Asymmery in he face of a change in governmen spending may be a funcion of condiions on he demand and/or supply side of he economy (Kandil, 1995, 1996, 1998, and 1999; Karras, 1996a, 1996b; Apergis e al., 2005). To illusrae, consider he following reduced-form equaion: Dv x = + j= 0 x g g β pvj posg β nvj negg, v = y, p, j (1) j j= 0 where D ( ) is he firs-difference operaor, he log of real oupu is denoed y, and he log value of he price level is denoed p. Governmen spending shocks comprise disribued lags of posiive and negaive shocks, posg and negg j. The j difference beween β g and pvj β g measures asymmery in each variable s nvj response o governmen spending shocks. The β parameers vary in response o wo facors: (1) he size of aggregae demand shifs in he face of he policy shock and/or (2) condiions on he supply side ha deermine capaciy consrains and price flexibiliy in he face of aggregae demand shifs. 2.1 Demand-Side Asymmery The size of he aggregae demand shif may be differen wih respec o he expansionary and conracionary shocks o governmen spending. The radiional view is ha an increase in governmen spending will simulae aggregae demand. Two facors deermine he size of aggregae demand shifs. Firs, binding liquidiy consrains may differeniae he effecs of governmen spending on
136 Inernaional Journal of Business and Economics financial markes. An increase in governmen spending is likely o increase he budge defici. To finance he increased spending, he governmen increases borrowing. Given he limied supply of available loanable funds above capaciy level, an increase in governmen spending raises he ineres rae, crowding ou privae spending. This channel moderaes he expansionary effecs of an increase in governmen spending on aggregae demand. As governmen deb builds up wih fiscal expansions, Miller e al. (1990) argue ha he moneary risk of defaul or increasing inflaion risk will reinforce crowding ou effecs hrough ineres raes. Hence, policy credibiliy is crucial. Tha is, if he governmen lacks a rack record of fiscal prudence, he ineres rae will mos likely reflec risk premia. Sizable risk premia represen perhaps he cleares reasons ha fiscal mulipliers could urn negaive. Privae spending decreases in he face of a rise in he ineres rae induced by sizable risk premia following fiscal expansion. 1 If crowding ou is larger in he face of expansionary governmen spending shocks, a smaller aggregae demand shif will differeniae he effecs of expansionary and conracionary shocks on produc and labor markes. In anoher direcion, some economiss have quesioned he imporance of changes in he ineres rae in response o governmen spending. They appeal o he Ricardian equivalence argumen o emphasize he effec of governmen spending on privae savings. 2 Given concerns abou he budge defici, agens foresee fuure ax liabiliies in response o higher governmen spending. Accordingly, privae consumpion is likely o decrease and savings will increase in response o higher governmen spending. The reducion in privae consumpion offses he posiive effec of governmen spending on aggregae demand and moderaes demand expansion. Risk-averse households are likely o assign high probabiliy o fuure ax liabiliy. 3 If consumers are more Ricardian in he face of expansionary governmen spending shocks, demand expansion is likely o be smaller, compared o conracion. 2.2 Supply-Side Asymmery Condiions on he supply side in he labor and/or produc markes may differeniae he slope of he aggregae supply curve in he face of expansionary and conracionary aggregae demand shifs. New Keynesian heoreical models have focused on marke imperfecions owards an explanaion of a kinked-supply curve. The source of asymmery has varied beween sicky-wage and sicky-price explanaions of business cycles. Sicky-wage models have raced sources of cyclical flucuaions o condiions in he labor marke (see for insance Gray, 1978). Implici or explici labor conracs may offer an explanaion of sicky wages. Given nominal wage rigidiy, an unanicipaed increase in price, e.g., in response o a posiive shock o governmen spending, decreases he real wage and increases he oupu supplied in he shor run. Condiions in he labor marke may differeniae, however, upward and downward nominal wage flexibiliy in he face of expansionary and conracionary demand shocks (see for example Ball e al., 1988). Implici or explici conracual wage agreemens may esablish ha nominal wage flexibiliy is asymmeric.
Magda Kandil 137 Asymmeric nominal wage flexibiliy may be he resul of insiuional seings which differeniae wage and salary negoiaions in he upward and downward direcions. During boom periods, cos of living adjusmens may be specified o guaranee workers an upward adjusmen of wages o keep up wih inflaion. In conras, firms may be relucan o ake aggressive measures owards adjusing nominal wages in he downward direcion during recessionary periods. This is because he search and raining cos of hiring new workers o accommodae a fuure rise in demand may acually exceed he perceived loss of reaining workers a wages ha exceed he marginal physical produc of labor during recessionary periods. Alernaively, he asymmeric flexibiliy of nominal wages maybe an endogenous response o aggregae uncerainy. Models of he variey of Gray (1978) have emphasized he dependency of he degree of indexaion on he variabiliy of sochasic disurbances. In a siuaion where posiive and negaive shocks are no equally variable, agens incenives for he opimal degree of indexaion would be asymmeric. In a scenario ha assumes more upward flexibiliy of he nominal wage, posiive demand shocks will promp an insananeous increase of wages. The upward flexibiliy of he nominal wage moderaes he reducion of he real wage and he increase in oupu growh in he face of expansionary demand shocks. Consequenly, higher demand will be refleced in a higher cos of he oupu produced and, in urn, higher prices. In conras, if nominal wages are more downwardly rigid, he counercyclical response (increase) of he real wage exacerbaes oupu conracion and moderaes price deflaion. Accordingly, asymmeric nominal wage adjusmen implies a seeper supply curve in he face of expansionary demand shifs, compared o conracionary shifs. Sicky-price explanaions have isolaed oupu flucuaions in he shor run from condiions in he labor marke (see for insance Ball and Mankiw, 1994). Menu coss limi he frequency of adjusing prices over ime. These are he coss involved in implemening and announcing a price change. Given price rigidiy, firms resor o adjusing oupu in he shor run in response o unanicipaed demand shifs, e.g., a posiive shock o governmen spending. Condiions in he produc marke may esablish, however, ha prices adjus asymmerically in he face of demand shocks. 4 Posiive rend inflaion plays a key role in inroducing asymmeries. Inflaion causes firms relaive prices o decline auomaically beween adjusmens. This requires greaer adjusmen of firms desired price in he face of posiive shocks, compared o negaive shocks. When a firm wans a lower relaive price in he face of negaive demand shocks, inflaion does much of he work, decreasing he need o pay he menu coss o adjus prices. By conras, a posiive demand shock means ha he desired relaive price increases while acual price is falling on accoun of high rend inflaion, creaing a large gap beween desired and acual prices. As a resul, posiive shocks are more likely o induce a larger price adjusmen, compared o negaive shocks. Asymmeric price adjusmen implies ha shifs in aggregae demand have asymmeric effecs on oupu. Since prices are sicky downward, a fall in aggregae
138 Inernaional Journal of Business and Economics demand is absorbed in oupu conracion. Higher upward flexibiliy of prices moderaes he oupu increase in response o expansionary demand shocks. Accordingly, asymmeric price adjusmen implies a seeper supply curve in he face of expansionary demand shifs, compared o conracionary shifs. The framework of his invesigaion is an empirical sudy of he effecs of he growh in governmen spending on demand componens, oupu growh, and price inflaion in a sample of developing and advanced counries. The empirical esimaion measures he elasiciy of specific demand componens in he face of governmen spending shocks. These parameers race channels of crowding ou on he demand side of he economy. The esimaion of empirical models ha measure he allocaion of governmen spending shifs beween real growh and price inflaion will measure supply-side consrains. To shed ligh on differences in he ransmission of governmen spending shifs across advanced and developing counries, cross-counry correlaion coefficiens will measure co-movemens on he demand and supply sides across counries of each group. 3. Empirical Framework The empirical model comprises reduced-form equaions explaining componens of aggregae demand (privae consumpion, privae invesmen, expors, and impors) as well as oupu growh and price inflaion. The growh componen of he series is he domain of real growh facors ha vary wih labor, capial and echnology. The resuls indicae ha his componen is non-saionary. 5 To accoun for non-saionariy, empirical models are esimaed in firs-differenced form. Flucuaions in he esimaed dependen variables are aribued o a variey of shocks impinging on he economic sysem. Assume aggregae demand shocks are disribued symmerically around an anicipaed seady sae rend over ime. This rend is consisen wih capaciy uilizaion in he economy and varies wih agens forecass of he deerminans of aggregae demand in equilibrium. Shocks o aggregae demand develop randomly around he forecased rend and deermine cyclicaliy in oupu growh and price inflaion. Aggregae demand varies wih he major deerminans of domesic and foreign demand. On he domesic fron, policy variables include governmen spending and he money supply. To accoun for ineracion wih he res of he world hrough he curren and capial accouns, he model specificaion also includes he exchange rae. Assume shocks o governmen spending are disribued randomly around a seady sae moving rend over ime. This rend varies wih variables ha deermine he growh of governmen spending over ime. Flucuaions around his rend are symmerically disribued. Flucuaions in he face of governmen spending shocks are likely o be deermined by demand and supply consrains. On he supply side, capaciy and insiuional consrains deermine price flexibiliy in he face of aggregae demand shifs. On he demand side, srucural parameers deermine he size of aggregae
Magda Kandil 139 demand shifs in he face of governmen spending shocks. A posiive shock o governmen spending increases demand and income. Through he muliplier process, he effec is furher reinforced on aggregae demand. Noneheless, he possibiliy of crowding ou may involve an offseing effec on privae spending. Moneary growh may vary o accommodae he growh of governmen spending and/or sabilize he exchange rae. Hence, boh shocks ener he empirical models. Underlying he model specificaion is he assumpion ha cyclical flucuaions in he oupu supplied is aribued o changes in he oupu price around is anicipaed value, i.e., oupu price surprises. These surprises are aribued o demand shocks ha include shocks o governmen spending, he money supply, and he exchange rae. These are he major deerminans of domesic and exernal demand in heory (for a deailed heoreical illusraion, see Kandil and Mirzaie, 2002). In addiion, flucuaions in he exchange rae may also deermine he oupu supplied. Given he dependency of developing counries on impored goods, a depreciaion of he exchange rae increases he cos of impored goods. Hence, he oupu supplied decreases. Accordingly, he empirical model is specified as follows: Dy Dp = β + β E Dg + β E Dm + β E 0 y 1y 1 2 y 1 3 y 1 + β + β 4 yp 6 yp 4 pp 6 pp posg posh + β + β 4 yn 6 yn 6 pn negg negh + η 4 pn + β 5 yp y 5 pp p posm + β = β + β E Dg + β E Dm + β E 0 p 1 p 1 2 p 1 3 p 1 + β + β posg + β posh + β negg + β negh + η posm Dh 5 yn + β negm Dh 5 pn negm (2) (3) where real oupu growh is denoed Dy, price inflaion is denoed Dp, and E ( ) is he expeced value of a variable a ime based on informaion available o agens a ime 1. By consrucion, anicipaed changes of variables on he righ-hand side of he empirical models are a funcion of lagged variables in he economic sysem, which capure persisence in adjusmens over ime. Having accouned for his persisence, only conemporaneous shocks appear in he model. The exchange rae measures he real price of he domesic currency relaive o a weighed average of currencies for major rading parners. An increase indicaes currency appreciaion. Anicipaed appreciaion of he exchange rae is denoed EDh, where EDg and EDm denoe anicipaed growh of governmen spending and he money supply. Posiive shocks o he exchange rae, posh, are unexpeced appreciaion of he domesic currency. Similarly, negh approximaes unexpeced depreciaion of he domesic currency. Expansionary and conracionary shocks o governmen spending are approximaed by posg and negg. Similarly, expansionary and conracionary shocks o he money supply are represened by posm and negm, while η y, and η p are random unexplained residuals wih zero mean and consan variance. To measure flucuaions on he demand side in response o governmen
140 Inernaional Journal of Business and Economics spending, he empirical models in (2) and (3) are replicaed o esimae growh in privae consumpion, Dcon, he growh in privae invesmen, Dinv, he growh in expors, Dexp, and he growh in impors, Dimp. Adjusmen in demand componens will deermine he ransmission channels of governmen spending shifs o oupu growh and price inflaion. Anicipaed appreciaion of he domesic currency decreases he demand for expors and increases demand for impors. Through his channel, real oupu growh and price inflaion decrease. Also on he demand side, unanicipaed appreciaion of he domesic currency may decrease money demand, as agens seek o capialize on higher han expeced currency value. Lower demand for money increases velociy and hence domesic demand, miigaing he negaive effecs on real oupu growh and price inflaion. On he supply side, unanicipaed currency appreciaion decreases he cos of impors and he oupu produced, increasing oupu growh and decreasing price inflaion. The opposie holds in he face of negaive shocks o he exchange rae, i.e., unanicipaed currency depreciaion. Srucural parameers deermine he ne effecs of currency flucuaions on oupu and price. Expansionary governmen spending shocks are expeced o increase demand and income. The resuling increase in money demand raises he ineres rae wih crowding ou effecs on aggregae demand. If he ne resul is posiive on aggregae demand, expansionary governmen spending shocks increase price inflaion and oupu growh. Through he income channel, governmen spending shocks are likely o have a posiive effec on consumpion growh. The effecs on invesmen spending will depend on he relaive effecs of governmen spending on income and he ineres rae. If he income channel dominaes, invesmen demand increases in response o higher governmen spending. Impors increase on accoun of higher domesic demand. The ne effec on expors is likely o depend, however, on he relaive srenghs of income and crowding ou channels following an increase in governmen spending. Expansionary moneary shocks increase liquidiy and, in urn, available credi. Subsequenly, aggregae demand increases wih posiive effecs on oupu growh and price inflaion. The effeciveness of moneary policy may be hampered, however, by accompanying domesic and exernal effecs. If moneary growh accommodaes an increase in governmen spending, inflaionary expecaion increases. Higher inflaionary expecaions may promp agens o decrease he demand for domesic currency, creaing addiional inflaionary pressure. As confidence is eroded in he abiliy of moneary policy o simulae growh, capial ouflow may furher couner he effeciveness of moneary policy. The combined effecs of he various channels will deermine he allocaion of moneary growh beween oupu growh and price inflaion. Moreover, he effecs of moneary growh on specific demand componens (privae consumpion, privae invesmen, expors, and impors) will be dependen on he relaive effecs on real growh and price inflaion. The difference beween he effecs of posiive and negaive shocks on economic variables measures asymmery. If he difference is posiive, he variabiliy
Magda Kandil 141 of governmen spending shocks has, on average, a posiive ne effec on variables growh. 4. Time Series Evidence The daa under invesigaion are annual for a sample of 18 developing and 25 advanced counries. Developing counries are seleced based on daa availabiliy wih an objecive o have a diverse sample based on income and geographical locaion. Counries in he advanced group are based on he IMF classificaion in he World Economic Oulook (WEO) daa base. The sample period for invesigaion covers 1976 2006. Appendix B oulines variables descripion and daa sources. Table 1A summarizes he mean and variance of seleced ime series saisics wihin counries: growh of governmen spending, real growh, price inflaion, consumpion growh, invesmen growh, impor growh, and expor growh. In general, developing counries are characerized by higher average growh and higher variabiliy of governmen spending, compared o advanced counries. While indicaors of real growh are no pronouncedly differen beween he wo groups, oher indicaors (price inflaion, consumpion growh, invesmen growh, expor growh, and impor growh) are pronouncedly higher in developing counries, compared o advanced counries. The empirical models (2) and (3) are esimaed joinly wih he equaions ha deermine agens forecass of variables ha ener he empirical model (see Appendix A for deails). Deailed resuls for real oupu growh, price inflaion, and componens of aggregae demand are available upon reques. Predicor Variable Table 1A. Summary Saisics across Counries Saisic Advanced Counries Developing Counries Mean SD Mean SD Growh of governmen spending Mean 0.11 0.06 0.26 0.24 Variance 0.11 0.06 0.29 0.31 Response Real growh Mean 0.04 0.02 0.04 0.01 Variance 0.03 0.02 0.05 0.03 Price inflaion Mean 0.08 0.07 0.18 0.14 Variance 0.06 0.08 0.29 0.37 Consumpion growh Mean 0.11 0.06 0.26 0.23 Variance 0.07 0.08 0.26 0.35 Invesmen growh Mean 0.11 0.06 0.26 0.19 Variance 0.12 0.07 0.39 0.39 Expor growh Mean 0.12 0.05 0.27 0.20 Variance 0.10 0.07 0.38 0.42 Impor growh Mean 0.11 0.06 0.27 0.20 Variance 0.12 0.08 0.36 0.40
142 Inernaional Journal of Business and Economics Table 1B summarizes means and variances of he variables responses o anicipaed shifs in governmen spending, posiive shocks, and negaive shocks across he samples of developing and advanced counries. To save space, only parameers ha measure he effecs of governmen spending are shown. Table 1B. Responses o Governmen Spending Shifs in Developing and Advanced Counries Counry Governmen Real growh Price inflaion Cons. growh group spending shifs Mean SD Mean SD Mean SD Developing Anicipaed 0.02 0.23 0.36 0.37 0.32 0.42 Advanced Anicipaed 0.11 0.30 0.37 0.31 0.25 0.34 Developing Posiive Shocks 0.01 0.31 0.31 0.83 0.47 0.94 Advanced Posiive Shocks 0.16 1.02 0.17 0.56 0.23 0.47 Developing Negaive Shocks 0.05 0.21 0.10 0.64 0.01 0.60 Advanced Negaive Shocks 0.07 0.63 0.14 0.48 0.17 0.43 Counry Governmen Invesmen growh Impor growh Expor growh group spending shifs Mean SD Mean SD Mean SD Developing Anicipaed 0.38 1.15 0.22 0.91 0.26 0.66 Advanced Anicipaed 0.16 2.28 0.09 1.30 0.18 1.06 Developing Posiive Shocks 0.27 1.82 0.17 0.89 0.21 1.19 Advanced Posiive Shocks 0.09 2.80 0.10 1.13 0.10 0.93 Developing Negaive Shocks 0.37 1.28 0.29 1.19 0.39 8.60 Advanced Negaive Shocks 0.13 1.86 0.31 1.30 0.13 0.85 Noes: Means are average ime series responses across he group of counries o governmen spending shifs, and SDs are sandard deviaions across ime series esimaes. 4.1 Oupu Growh In general, anicipaed growh of governmen spending has significan negaive effecs on real growh in a number of advanced counries. Anicipaed increase in governmen spending capures anicipaion in response o lagged economic condiions ha deermine agens forecass. The negaive response of real growh indicaes failure of he fiscal simulus o revive growh in a imely span. Growh does no respond posiively o anicipaed growh in governmen spending wihin a year, indicaing ineffeciveness of he fiscal simulus in seady sae. Anicipaed increase in governmen spending riggers anicipaion of igher consrains on credi availabiliy and a higher cos of borrowing, wih poenial adverse effecs on growh. The negaive significan effecs of expansionary governmen spending shocks on real growh remain prevalen across advanced counries, providing furher suppor o he adverse effec of higher governmen spending on economic aciviy across advanced counries. Consisenly, he reducion in governmen spending eases binding consrains on credi availabiliy, simulaing real growh, as eviden by he negaive significan response o conracionary shocks. Across developing counries, he evidence provides less suppor for he crowding ou channel of an increase in governmen spending. The negaive significan response of real growh o anicipaed growh and expansionary shocks o
Magda Kandil 143 governmen spending appear less prevalen across developing counries, compared o advanced counries. In general, conracionary governmen spending shocks appear insignifican on real growh, excep for a few significan negaive responses, indicaing moderae increase in real growh despie fiscal conracion. The evidence across developing and advanced counries highlighs a few differences. Consisen wih near full uilizaion of available resources, financing consrains are more binding in advanced counries. In conras, excess liquidiy and idle resources in many developing counries avail financing for an increase in governmen spending, while limiing he crowding ou effec on privae spending. A few specifics in developing counries are relevan in his conex: he underdevelopmen of he financial sysem, inefficien inermediaion, high saving raes, high risk of lending o he privae secor, and limied lending opporuniies in highly undiversified economies. 4.2 Price Inflaion In conras o he limied effec of anicipaed governmen spending on real growh across advanced counries, he effecs on price are more pervasive in suppor of long-lasing significan inflaionary effecs. The inflaionary effec of expansionary shocks o governmen spending appears less eviden. The deflaionary effec of conracionary governmen spending shocks appears, in general, limied. Across developing counries, he inflaionary effecs of anicipaed governmen spending shifs are generally larger, relaive o heir real effecs on growh. The inflaionary effec of expansionary governmen spending shocks is even more pervasive, compared o ha of anicipaed shifs. Downward rigidiy of price inflaion is more prevalen, however, across developing counries, compared o advanced counries. Clearly, he evidence spells ou rigidiy o adjus prices downward despie high rend inflaion in many developing counries. In Table 1A, he mean and variance of price inflaion are much higher across developing counries, compared o advanced counries. Across developing counries, average rend inflaion over ime ranges from a low of 5% in Saudi Arabia o a high of 56% in Argenina. In conras, across advanced counries, he average inflaion over ime ranges from a low of 2.3% in Germany o a high of 34% in Israel. As noed in Secion 2, boh sicky-wage and sicky-price models predic less downward flexibiliy of wages and/or prices in he face of higher rend inflaion. Agens are more relucan o adjus wages and/or prices downward in anicipaion of higher price inflaion. 4.3 Privae Consumpion Growh Across advanced counries, anicipaed growh of governmen spending is an imporan deerminan of privae consumpion, as eviden by he significan posiive response. Accordingly, anicipaed growh of governmen spending deermines planned income and he seady growh of privae consumpion. There is also evidence of cyclicaliy in privae consumpion growh wih respec o expansionary shocks o governmen spending. The reducion in privae consumpion wih respec
144 Inernaional Journal of Business and Economics o random conracion in governmen spending is less pervasive. Noneheless, he evidence indicaes flexibiliy o adjus consumpion downward during cyclical downurns in a few counries. Across many developing counries, governmen spending is likely o play a larger role in providing employmen and supporing growh, compared o advanced counries. In suppor of his role is he posiive and significan response of privae consumpion o anicipaed growh in governmen spending in many counries. The cyclical increase in privae consumpion wih respec o expansionary shocks o governmen spending, alhough less pervasive, is robus, signifying he role of governmen spending in supporing privae income. In conras, he response of privae consumpion o conracionary governmen spending shocks appears less pervasive, indicaing acyclical response, in general. The evidence highlighs some difference regarding he role of governmen spending in simulaing consumpion growh across developing and advanced counries. Planned consumpion, in many advanced and developing counries, is ied o anicipaed growh in governmen spending, reflecing movemen in permanen income and raional expecaions. Cyclicaliy spells ou, however, a bigger role of governmen spending in developing counries in sabilizing economic condiions and weahering he adverse effecs of exogenous shocks. 4.4 Invesmen Growh Across advanced counries, he response of privae invesmen o anicipaed shifs in governmen spending provides furher evidence in suppor of crowding ou. This is eviden by he significan negaive response of privae invesmen growh o anicipaed growh of governmen spending, in general. Significan responses of privae invesmen o expansionary shocks are mixed, combining boh negaive responses in suppor of crowding ou and posiive responses in suppor of he fiscal simulus. Similarly, conracionary shocks have mixed significan effecs on privae invesmen growh. Negaive effecs indicae an increase, while posiive effecs indicae a reducion in privae invesmen growh in he face of conracionary governmen spending shocks. Across developing counries, he evidence highlighs limied crowding ou effecs, compared o advanced counries. The significan response of privae invesmen growh o flucuaions in governmen spending, boh anicipaed as well as expansionary and conracionary shocks, is primarily posiive. Accordingly, he growh of governmen spending provides a necessary simulus o spur growh of privae invesmen, in general, across counries. As many advanced counries employ exising resources near full uilizaion, an increase (decrease) in governmen spending increases (relaxes) consrains on available financing, limiing (availing) resources o finance privae aciviy. In conras, privae invesmen decisions are mosly dependen on economic condiions in developing counries, and governmen spending provides he necessary simulus o mobilize privae resources.
Magda Kandil 145 4.5 Impor Growh Across advanced counries, he crowding ou channel remains prevalen in he response of impors o anicipaed growh of governmen spending. The evidence differeniaes, however, he effecs of anicipaed and unanicipaed increase in governmen spending on impors. Limied significan effecs on impor growh signify he role of conracionary governmen spending shocks in slowing down economic aciviy and impor growh. Across developing counries, impor growh is eviden o respond significanly o anicipaed growh in governmen spending in many counries. In conras, he ransiory effecs of expansionary shocks o governmen spending appear raher limied on impor growh. The conracionary effec of a slowdown in governmen spending is generally more prevalen across developing counries. Overall, he evidence does no highligh pronounced differences beween he effecs of governmen spending on impor growh in developing and advanced counries. 4.6 Expor Growh Across advanced counries, he growh of governmen spending is an imporan deerminan of flucuaions in expors. Anicipaed growh in governmen spending conribues o a surge in expor growh in several counries. The impac of cyclical flucuaions in governmen spending appears less pronounced on expor growh across counries. The evidence suppors, however, conracion in expor growh in response o a slowdown in governmen spending. Across developing counries, he evidence indicaes a relaively more imporan role for he fiscal simulus o revive expor growh, compared o advanced counries. Variaion in expor growh wih expansionary governmen spending shocks appears less prevalen, compared o planned adjusmen wih respec o anicipaed shifs. Expors, in developing counries, are mosly raw maerials and agriculural producs ha vary more closely wih anicipaed developmen in exernal demand, compared o domesic condiions. Noneheless, a slowdown in governmen spending may shrink expor growh in developing counries. 5. Cross-Secion Analysis To shed addiional ligh on he differences beween variables adjusmens o governmen spending shifs in developing and advanced counries, he paper urns o an analysis of he ime series evidence in hree differen direcions. 1. Cross-counry correlaions measure co-movemens in he variables responses o each componen of governmen spending shifs anicipaed growh, expansionary shocks and conracionary shocks across he samples of advanced and developing counries. Tables 2A, 3A, and 4A summarize correlaions beween he responses of dependen variables o shifs in
146 Inernaional Journal of Business and Economics governmen spending across advanced counries. Tables 2B, 3B, and 4B summarize correlaions across developing counries. 2. Cross-counry regressions measure he impac of variabiliy in governmen spending on he rends of real oupu growh, price inflaion, and he averages of he growh in privae consumpion, privae invesmen, expors, and impors. Resuls are summarized in Tables 5A and 5B. 3. Cross-counry regressions measure he impac of variabiliy in governmen spending on he variabiliy of real oupu growh, price inflaion, and growh in privae consumpion, privae invesmen, expors, and impors. Resuls are summarized in Tables 6A and 6B. The resuls will conras he evidence across developing and advanced counries. 5.1 Co-Movemens in Response o Anicipaed Shifs in Governmen Spending Based on saisical significance of correlaion coefficiens, he following paerns emerge. Across developing counries (Table 2A), anicipaed growh in governmen spending simulaes oupu (income) growh, which correlaes wih an increase in privae spending on consumpion and invesmen as well as a surge in impor demand. The increase in privae consumpion is a major source of inflaion. Correlaion coefficiens indicae larger conribuion of invesmen demand, compared o consumpion demand, o impor growh. Across advanced counries (Table 2B), similar paerns emerge. In paricular, real growh in he face of anicipaed governmen spending correlaes wih growh in privae invesmen and impors. As anicipaed growh of governmen spending crowds ou privae invesmen, i correlaes wih a reducion in oupu and impor growh. The increase in consumpion is paricularly inflaionary, as eviden by he significan posiive correlaion coefficien. Table 2A. Correlaion Marix across Advanced Counries wih Respec o Anicipaed Governmen Spending Shifs Dp 0.21 Dy Dp Dcon Dinv Dexp Dimp (0.30) Dcon 0.41* 0.38* (0.034) (0.048) Dinv 0.49* 0.11 0.54* (0.0099) (0.58) (0.0034) Dexp 0.28 0.15 0.45* 0.43* (0.16) (0.46) (0.02) (0.025) Dimp 0.58* 0.037 0.68* 0.78* 0.68* (0.0017) (0.86) (0.0001) (0.0001) (0.0001) Dbal 0.044 0.23 0.18 0.00017 0.14 0.066 (0.83) (0.26) (0.38) (0.99) (0.48) (0.74) To summarize, major differences regarding variables comovemens in he face
Magda Kandil 147 of anicipaed increase in governmen spending across developing and advanced counries are as follows: (1) co-movemen in oupu growh and price inflaion is negaive across advanced counries, in suppor of he crowding ou effec of governmen spending, (2) he inflaionary effec of an increase in consumpion is much more pronounced across developing counries, and (3) he increase in expors is an inegral componen across advanced counries. Table 2B. Correlaion Marix across Developing Counries wih Respec o Anicipaed Governmen Spending Shifs Dy Dp Dcon Dinv Dexp Dimp Dp 0.13 (0.59) Dcon 0.50* 0.76* (0.033) (0.0002) Dinv 0.85* 0.29 0.46* (0.0001) (0.24) (0.058) Dexp 0.064 0.25 0.18 0.14 (0.80) (0.32) (0.47) (0.59) Dimp 0.70* 0.23 0.57* 0.82* 0.38 (0.0012) (0.35) (0.014) (0.0001) (0.12) Dbal 0.04 0.48* 0.36 0.12 0.16 0.18 (0.88) (0.051) (0.16) (0.64) (0.54) (0.48) Noes: Dy is real oupu growh, Dp is price inflaion, Dcon is growh of privae consumpion, Dinv is growh of privae invesmen, Dexp is growh of expors, Dimp is growh of impors, Dbal is change in rade balance. P-values are in parenheses. * and ** denoe significance a 10% and 5% levels. 5.2 Co-Movemens in Response o Expansionary Shocks o Governmen Spending Flucuaions in response o governmen spending shocks provide similar, alhough somewha differen, paerns of correlaion. Across developing counries (Table 3A), expansionary shocks o governmen spending simulae growh, which appears o be correlaed wih an increase in invesmen and impor growh. An increase in privae consumpion correlaes wih a large inflaionary effec. The growh of invesmen appears o be correlaed wih higher impors. Across advanced counries (Table 3B), an increase in impor growh correlaes wih an increase in consumpion and invesmen growh. Unique, however, for advanced counries is he effec of he increase in impors in simulaing expor growh. To summarize, major differences regarding variables co-movemens in he face of expansionary shocks o governmen spending across developing and advanced counries are as follows: (1) he inflaionary effec of an increase in consumpion growh is much more pronounced across developing counries and (2) higher growh generaes larger increase in impors across developing counries. Higher impors correlae wih expor growh across advanced counries.
148 Inernaional Journal of Business and Economics Table 3A. Correlaion Marix across Advanced Counries wih Respec o Posiive Governmen Spending Shocks Dp Dy Dp Dcon Dinv Dexp Dimp 0.36** (0.062) Dcon 0.30 0.17 (0.13) (0.39) Dinv 0.27 0.33** 0.74* (0.17) (0.096) (0.0001) Dexp 0.025 0.37* 0.022 0..065 (0.90) (0.058) (0.92) (0.75) Dimp 0.20 0.009 0.54* 0.60* 0.49* (0.32) (0.96) (0.0034) (0.001) (0.01) Dbal 0.052 0.11 0.12 0.07 0.27 0.031 (0.80) (0.59) (0.54) (0.73) (0.17) (0.88) Table 3B. Correlaion Marix across Developing Counries wih Respec o Posiive Governmen Spending Shocks Dy Dp Dcon Dinv Dexp Dimp Dp 0.29 (0.23) Dcon 0.04 0.92* (0.88) (0.0001) Dinv 0.80* 0.16 0.05 (0.0001) (0.53) (0.84) Dexp 0.22 0.21 0.054 0.14 (0.38) (0.41) (0.83) (0.58) Dimp 0.69* 0.046 0.094 0.78* 0.22 (0.0016) (0.85) (0.71) (0.0001) (0.38) Dbal 0.19 0.079 0.19 0.24 0.043 0.36 (0.46) (0.76) (0.46) (0.35) (0.87) (0.16) Noes: Noes: Dy is real oupu growh, Dp is price inflaion, Dcon is growh of privae consumpion, Dinv is growh of privae invesmen, Dexp is growh of expors, Dimp is growh of impors, Dbal is change in rade balance. P-values are in parenheses. * and ** denoe significance a 10% and 5% levels. 5.3 Co-Movemen in Response o Conracionary Shocks o Governmen Spending Across developing counries (Table 4A), he correlaion beween price inflaion and privae consumpion growh remains robus. Boh are negaively correlaed wih oupu growh, implying downward price rigidiy during a slowdown. Similarly, expor growh correlaes negaively wih real oupu growh, implying greaer dependence of expor growh on exernal demand. Across advanced counries (Table 4B), deflaion correlaes, on average, wih an
Magda Kandil 149 increase in real growh. As governmen spending decreases, more resources are available in suppor of privae secor aciviy and real growh. Invesmen growh correlaes wih consumpion growh, and boh are highly correlaed wih impor growh. Flucuaions in expors vary significanly wih movemens in oher demand componens. To summarize, major differences regarding variables co-movemens in he face of conracionary shocks o governmen spending across developing and advanced counries are as follows: (1) he reducion in consumpion correlaes wih price deflaion across developing counries and (2) oupu growh is increasing, despie conracionary shocks, and correlaes wih an increase in spending on consumpion and invesmen across advanced counries. Table 4A. Correlaion Marix across Advanced Counries wih Respec o Negaive Governmen Spending Shocks Dy Dp Dcon Dinv Dexp Dimp Dp 0.27 (0.17) Dcon 0.36** 0.21 (0.067) (0.29) Dinv 0.32 0.10 0.70* (0.11) (0.61) (0.0001) Dexp 0.11 0.029 0.31 0.059 (0.57) (0.89) (0.11) (0.77) Dimp 0.28 0.092 0.66* 0.45* 0.77* (0.15) (0.65) (0.0002) (0.018) (0.0001) Dbal 0.17 0.041 0.27 0.13) 0.28 0.31 (0.42) (0.84) (0.18) (0.53) (0.17) (0.12) Table 4B. Correlaion Marix across Developing Counries wih Respec o Posiive Governmen Spending Shocks Dy Dp Dcon Dinv Dexp Dimp Dp 0.45* (0.056) Dcon 0.42** 0.83* (0.084) (0.0001) Dinv 0.27 0.036 0.16 (0.28) (0.89) (0.53) Dexp 0.41** 0.62* 0.67* 0.16 (0.09) (0.007) (0.0026) (0.52) Dimp 0.054 0.25 0.32 0.60* 0.48* (0.83) (0.32) (0.20) (0.0086) (0.046) Dbal 0.11 0.17 0.19 0.15 0.14 0.004 (0.67) (0.52) (0.48) (0.58) (0.59) (0.99) Noes: Noes: Dy is real oupu growh, Dp is price inflaion, Dcon is growh of privae consumpion, Dinv is growh of privae invesmen, Dexp is growh of expors, Dimp is growh of impors, Dbal is change in rade balance. P-values are in parenheses. * and ** denoe significance a 10% and 5% levels.
150 Inernaional Journal of Business and Economics 5.4 Differences in Trends wih Governmen Spending Variabiliy Cross-counry regressions esimae he effecs of he variabiliy of governmen spending on variables rends. Table 5A summarizes he effecs of he variabiliy of governmen spending on rend variables across advanced counries. Table 5B presens he resuls across developing counries. The sandard deviaion of shocks o growh in governmen spending measures variabiliy. Variabiliy is he resul of posiive and negaive shocks ha are assumed o follow a symmeric disribuion. Symmeric effecs of random shocks will produce neural resuls ha cancel ou wihou affecing economic rends. In conras, larger effecs of posiive shocks, relaive o negaive shocks, would resul in a posiive ne conribuion, increasing rends over ime. There are wo scenarios where he effec of expansionary shocks o governmen spending could exceed ha of negaive shocks. Firs, he simulus effec of expansionary shocks may dominae he conracionary effec of he fiscal wihdrawal on income and relaed economic aciviy. Second, crowding ou may be larger in he face of negaive shocks, compared o posiive shocks. Tha is, he increase in privae invesmen wih respec o conracionary governmen spending shocks dominaes he reducion in he face of expansionary shocks. Table 5A. The Impac of Governmen Spending Variabiliy on Trends across Advanced Counries Response Consan Predicor Variabiliy of governmen spending Average real growh 0.027* 0.11* 0.20 (4.90) (2.57) Average price inflaion 0.025 0.95* 0.61 ( 1.39) (6.51) Average privae consumpion growh 0.006 1.013* 0.92 ( 0.77) (17.54) Average privae invesmen growh 0.0063 0.97* 0.92 ( 0.93) (17.90) Average expor growh 0.041* 0.69* 0.74 (4.23) (8.87) Average impor growh 0.007 0.96* 0.88 (0.83) (14.03) The evidence indicaes ha he effecs of posiive shocks dominae ha of negaive shocks, resuling in a posiive ne conribuion of variabiliy o economic rends. Across advanced counries, higher variabiliy of governmen spending increases rends of all variables: real growh, price inflaion, privae consumpion growh, privae invesmen growh, expor growh, and impor growh. Across developing counries, he posiive effecs of he variabiliy of governmen spending on rends remain robus wih one excepion. Higher variabiliy of governmen spending has a negaive alhough saisically insignifican effec on 2 R
Magda Kandil 151 rend real oupu growh. While he ime series evidence spells ou limied crowding ou effecs, he conracionary effec of spending shocks exceeds he expansionary effec on real growh. The difference may be aribued o consrains and srucural bolenecks in developing counries ha limi oupu expansion in he face of expansionary governmen spending shocks. In ligh of hese consrains, he variabiliy of governmen spending fails o induce significan expansion and he conracionary effec appears more dominan across developing counries. Table 5B. The Impac of Governmen Spending Variabiliy on Trends across Developing Counries Response Consan Predicor Variabiliy of governmen spending Average real growh 0.043* 0.013 0.12 (11.87) ( 1.55) Average price inflaion 0.077* 0.36* 0.67 (3.12) (6.09) Average privae consumpion growh 0.063* 0.69* 0.89 (2.70) (13.34) Average privae invesmen growh 0.096* 0.57* 0.84 (3.84) (9.59) Average expor growh 0.098* 0.59* 0.85 (4.01) (10.18) Average impor growh 0.094* 0.59* 0.82 (3.43) (9.10) Noes: Moneary variabiliy is he sandard deviaion of growh in he money supply. -saisics are in parenheses. * and ** denoe significance a he 10% and 5% levels. 5.5 Differences in Variabiliy wih Governmen Spending Table 6A summarizes he effecs of he variabiliy of governmen spending on he variabiliy of economic variables across advanced counries. Table 6B presens he resuls across developing counries. Across advanced counries, he variabiliy of governmen spending increases he variabiliy of all variables under consideraion. Across developing counries, in conras, he variabiliy of governmen spending significanly increases he variabiliy of all variables, excep for real growh. The difference furher reinforces limiaion o expand oupu growh in he face of expansionary shocks o governmen spending in several developing counries. In ligh of his srucural limiaion, he effec of he fiscal simulus on oupu growh is limied, miigaing oupu variabiliy in response o governmen spending variabiliy. Two ineresing resuls emerge. Firs, governmen spending plays a leading role in deermining economic condiions in advanced counries. The variabiliy of governmen spending increases rend real growh over ime, while conribuing o more variabiliy in he economic sysem. Minimizing he variabiliy of governmen spending may be beneficial o susain growh and reduce cyclical variabiliy. Second, variabiliy of governmen spending is derimenal o growh in developing counries 2 R
152 Inernaional Journal of Business and Economics in wo direcions. I fuels price inflaion and enrenched expecaions, wihou increasing rend real growh. Moreover, excessive variabiliy of governmen spending increases aggregae uncerainy. Table 6A. The Impac of Governmen Spending Variabiliy on Economic Variabiliy across Advanced Counries Response Consan Predicor Variabiliy of governmen spending Variabiliy of real growh 0.022* 0.093** 0.10 (3.21) (1.73) Variabiliy of price inflaion 0.067* 1.15* 0.78 ( 4.44) (9.52) Variabiliy of privae consumpion growh 0.053* 1.11* 0.75 ( 3.37) (8.79) Variabiliy of privae invesmen growh 0.021 0.93* 0.73 (1.55) (8.47) Variabiliy of expor growh 0.013 1.021* 0.80 ( 1.07) (10.34) Variabiliy of impor growh 0.021 0.91* 0.50 (0.95) (5.12) Table 6B. The Impac of Governmen Spending Variabiliy on Economic Variabiliy across Advanced Counries Response Consan Predicor Variabiliy of governmen spending Variabiliy of real growh 0.043* 0.021 0.073 (5.65) (1.19) Variabiliy of price inflaion 0.039 1.12 0.89 ( 1.01) (12.23) Variabiliy of privae consumpion growh 0.058* 1.10* 0.95 ( 2.46) (19.43) Variabiliy of privae invesmen growh 0.044 1.18* 0.89 (1.05) (11.83) Variabiliy of expor growh 0.0078 1.29* 0.94 (0.23) (16.15) Variabiliy of impor growh 0.0023 1.24* 0.93 ( 0.07) (15.66) Noes: Variabiliy is he sandard deviaion of growh in he relevan variable. -saisics are in parenheses. * and ** denoe saisical significance a he 10% and 5% levels. To enhance he effeciveness of governmen spending, prioriies should aim a relaxing srucural bolenecks ha hinder growh in developing counries or crowd ou privae resources in advanced counries. Concurrenly, discreionary fiscal spending should refrain from pro-cyclicaliy ha exacerbaes he variabiliy of 2 R 2 R