fiscal & monetary: it takes two to tango robert tchaidze, iset for the nbg conference on...

FISCAL & MONETARY: IT TAKES TWO TO TANGO

Robert TCHAIDZE, ISET

For the NBG conference on monetary policy

June 26, 2009 Robert Tchaidze: FISCAL & MONETARY 2

The Main Messages Coordination of fiscal and monetary is …

… important; … even more so in a country like Georgia; … under any monetary regime; … in any macroeconomic circumstances.

NB: this presentation is not about the country of Georgia. It is about a country like Georgia.


Motivation and Theory Simple macroeconomic models show that a

policy measure by monetary can be undone or exaggerated by fiscal and vice versa.

Wrong moves do not need to be actually happening. Expectations that they may happen are enough to screw things up.


Motivation and Theory This needs to be sufficiently appreciated. Lack of coordination shows up in variables

(inflation, interest rate, exchange rate) that are easier to attribute to monetary than fiscal.

Hence, very tempting to take actions driven by political agenda and place the blame with monetary.


What can go wrong: Traditional story:

Spending → inflation; Domestic borrowing → interest rates; FX privatization/borrowing → exchange rates.

Less so: Quasi-fiscal operations; Functioning of T-bill/liquidity market.


Coordination Macroeconomic management:

Level of deficit; Domestic and foreign borrowing; Composition of spending (current/capital).

Liquidity management: Timing of spending, borrowing, payments, FX

conversion; Maintenance of T-bill market.


Coordination is important under any monetary regime Fixed exchange rate regime (peg):

Persistent budget deficits drain reserves forcing CB to abandon the peg.

Currency board/dollarization/currency union: Loose fiscal policy (excessive spending or low

taxes) leads to real exchange rate appreciation. Free float (either IT or Dual Target) :

Loose fiscal policy (excessive spending or low taxes) leads to inflation.


Structurally changing economies I.e., transitional/developing economies,

emerging markets where new rules, mechanisms, structures are being set up.

Often these are small open economies with their own currencies.

In such economies the issues become much more problematic than in developed economies.


Structurally changing economies Potential of monetary is limited; Scale of things is much bigger (massive

inflows, total privatization, sweeping reforms); Politics dominated by one party; party

dominated by few individuals; Business-politics connections tighter; Public awareness is limited.


Examples These are clearly economic decisions but they

could to a larger than warranted degree be reflective of political considerations: Social safety net spending; Tax cuts; Privatization; Donor aid.

These are reasonable and warranted actions that may have very unpleasant consequences.


Iceland Banks were a big part of the story but not the only

one. The other parts are reflective of politics and

structural changes: Investment into aluminum industry; Tax cuts; Housing fund.

Directly contributed to overheating. Indirectly, as these helped establish an image of a

dynamic transforming country, inducing foreigners to invest into it and Icelanders to spend.


Iceland Consequences:

Exchange rate appreciation; Inflation; Asset (real estate and stock market) bubbles; Huge current account deficit; High level of household and external debt.

Very different views held by the Central Bank and Ministry of Finance staff. E.g. output gap estimates: +5 percent (CBI); +1 percent (MoF)

Budget surpluses of 5 percent of GDP, creating an impression of tight fiscal policy.


The Main Messages Coordination of fiscal and monetary is …

… important; … even more so in a country like Georgia; … under any monetary regime; … in any macroeconomic circumstances.

NB: this presentation is not about the country of Georgia. It is about a country like Georgia.

fiscal & monetary: it takes two to tango robert tchaidze, iset for the nbg conference on...

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