Fiscal Dominance in the WAMZ: An Empirical Investigation Ibrahima DIALLO and Isatou MENDY Ninth Annual Conference on Regional Integration in Africa (ACRIA 9) - Banjul July 9, 2018

Is Africa Emerging? Interrelation bw FP and MP Introduction Is Africa Emerging? Interrelation bw FP and MP How government finance the fiscal gap? What is the role of the central bank and monetary authority behavior vis a vis to the government? How surplus responds to change in debt to ensure solvency?

Introduction In a “normal” situation: fiscal authority adjusts PB to reduce debt accumulation i.e. surplus responds to change in debt to ensure solvency no policy accommodation by the monetary authority Central bank able to neutralize government financial demands Policy coordination bw MA and FA Monetary Dominant (MD) or Ricardian (R) regime (Sargent and Wallace, 1981)

Introduction However, many developing countries are not in “normal” situation, given: revenue short falls under developed financial market difficulty in accessing external finance cheap central bank financing political economy ………. Government relies on central bank financing……….excess of seignorage - Lack of discretionary MP Fiscal Dominant (MD) or non-Ricardian (NR) regime

Introduction In which case: fiscal authority prepares the budget independently of public liabilities levels leading to a large and persistent fiscal deficits central bank accommodates most government financial demands to ensure that the fiscal policy remains solvent High inflation (Fisher and Easterly, 1990) agreement with Friedman that inflation “is always and everywhere a monetary phenomenon”, but adding that “rapid inflation is almost always a fiscal phenomenon”

Introduction Effects and implications of FD regime: fiscal policy characterized by a pro-deficit bias and a procyclicality behavior in most developing countries pro-deficit bias in fiscal policy transmitted directly into a pro-inflationary bias of the central bank (Montiel P, 2013) significant cost for monetary policy authority Disruption/macroeconomic instability in most advanced and emerging economies: fiscal institutions built on fiscal rules and operating on target- oriented and/or procedure oriented basis

Introduction In the WAMZ, convergence criteria playing as de facto fiscal and monetary rules to meet for the commencement of the monetary union. These criteria are: Fiscal deficit ≤3%; single digit Inflation ; Gross external reserves ≥3; CB financing deficit: ≤10% of previous year’s tax revenue; Exchange Rate Variation: +/- 10%; Public Debt: ≤70% GDP Also, member countries (ex Nigeria) being in a program with the IMF which imposes a set of rules called Performance Criteria and Indicative Targets However, performances in meeting the criteria has been mixed. Worsening fiscal deficits, increase CB financing and edging inflation in most cases attributed to governments’ spending outlays and an absence of policy coordination (WAMI, 2016). IMF Criteria vs Ecowas Criteria: Accountability matters Could be a case of FD regime

Introduction Given the characteristics of a FD regime presented above which are more evident in developing countries (Carlos de Resende, 2007) and the challenges that the WAMZ countries are facing in meeting the convergence criteria, it would be important to investigate the possible presence of fiscal dominance in the WAMZ economies.

Theoretical framework In order to finance its deficit, the public sector has mainly three (3) options: printing money (Seignorage), use of foreign reserve or borrowing (abroad or local) (Fisher and Easterly, 1990). The government intertemporal budget constraint 𝐵 𝑡 = 𝑀 𝑡+1 − 𝑀 𝑡 + 𝑇 𝑡 − 𝐺 𝑡 + 𝐵 𝑡+1 /(1+ 𝑟 𝑡 ) 𝑙𝑖𝑎𝑏 𝑡 = 𝑝𝑏 𝑡 ′ + 𝛿 𝑙𝑖𝑎𝑏 𝑡+1 𝑙𝑖𝑎𝑏 𝑡 = 𝑝𝑏 𝑡 ′ + 𝐸 𝑡 𝑗=𝑡+1 ∞ 𝑘=1 𝑗−1 𝛿 𝑘 𝑠 𝑗

Defining the fiscal and monetary dominant regimes from the government budget constraint From the following fiscal rule (or reaction function) 𝑝𝑏 𝑡 =𝛼 𝑙𝑖𝑎𝑏 𝑡+1 + 𝜀 𝑡 In a FD regime, PB is determined independently of the level of liabilities (𝛼 not statistically significant). In such a regime, the constraint is satisfied by the nominal income (Py) and/or the discount factor. On the other hand, in a MD regime, future liabilities play a significant role in adjusting the primary balance since the fiscal authority uses its current surplus to reduce future liabilities (𝛼 negative and statistically significant) (Woodford (1995) and Canzoneri, Cumby and Diba (2000)).

Public Liabilities and Primary Balance in the WAMZ

Public Liabilities and Primary Balance in the WAMZ

Public Liabilities and Primary Balance in the WAMZ

Model Specification, Data and Estimation Methodology VAR system of vector 𝑧 𝑡 = 𝑝𝑏 𝑙𝑖𝑎𝑏 ′ 𝑧 are observed annually 1990 - 2017 due to data constraint (e.g. Lib, SL) 𝑝𝑏 is the primary balance in percentage of GDP 𝐿𝑖𝑎𝑏 corresponds to liabilities (general government gross debt + reserve money) in percentage of GDP Our data are sourced from WAMI Database and from the World Economic Outlook (April 2018) of the IMF

Model Specification, Identification and Estimation Δ 𝑍 𝑡 = 𝑐+ 𝑗=1 𝑝 𝑅 𝑗 Δ 𝑍 𝑡−1 + µ 𝑡 Δ 𝑍 𝑡 = 𝐴(𝐿) 𝜀 𝑡 𝐴 𝑖𝑠 𝑎 2∗2 𝑚𝑎𝑡𝑟𝑖𝑐𝑒 and 𝜀 𝑡 = 𝜀 𝑡 𝑝𝑏 𝜀 𝑡 𝑙𝑖𝑎𝑏 ′ is a vector of structural disturbances namely primary balance shock and liabilities shock respectively – One restriction Δ 𝑝𝑏 𝑡 Δ 𝑙𝑖𝑎𝑏 𝑡 = . 0 . . 𝜀 𝑡 𝑝𝑏 𝜀 𝑡 𝑙𝑖𝑎𝑏 shocks on liabilities have no immediate impact on primary balance meaning that it is rather liabilities of previous periods that affect the current primary balance

Empirical Results

Empirical Results

Empirical Results

Empirical Results

Empirical Results

Dominant regime of the WAMZ Countries Country Responses of Regime 𝑷𝒃 𝒕 𝑳𝒊𝒂𝒃 𝒕+𝟏 The Gambia Positive Negative MD Ghana FD Guinea Nigeria Sierra Leone NS

Dominant regime of the WAMZ Countries For Nigeria, result in line with Sanusi and Akinlo’s (2016) findings not very surprising the central bank’s net claims on government has remained in negative territory since 2003 implying that the central bank is instead indebted to government and no need for central bank bailout in the form of central bank financing kept record of low level of liabilities (less than 20 percent of GDP) over the past decades although public debt have significantly increased over the last three years

Dominant regime of the WAMZ Countries The Gambia, findings could raise some questions given the fact that there has been rising high levels of debt from 2011 in recent years reaching above 100 percent of GDP in 2015. Government fiscal deficit was not heavily monetized by the central bank in many years. This is evident in the central bank’s net claims on government which was a net repayment to government in 2011 before growing significantly from 2014 resulting to Gambia been assessed in 2016 as being at high risk of debt distress.

Dominant regime of the WAMZ Countries In Ghana, Guinea and Sierra Leone where our findings indicate a non-Ricardian regime have undergone a lots of challenges regarding price stability and debt management compared to the other two WAMZ countries. Issues of managing debt accumulations and financing. In Ghana, the monetary authority has adopted inflation targeting as the monetary policy regime since 2007 but with significant challenges to achieve the target of (8 percent with ± 2 % 𝑏𝑎𝑛𝑑𝑠). This failure could be explained in part by the lack of effective monetary policy of the central bank which accommodates fiscal policy in Ghana

Conclusion and Policy Implications fiscal policy: based on an active reaction function/fiscal rules credibility and effectiveness “Target-oriented” rule: imposing numerical constraints on outcomes of certain variables such as the budget or the debt The rules should be legally backed and consequences laid for the breach of the rules. For instance, oil countries (Ghana and Nigeria) and mining countries (Ghana, Guinea, and Sierra Leone) should specify a nonoil/non mining balance to limit the negative impact of raw materials fluctuations on their solvency and sustainability. E.g. minimum structural surplus or a surplus adjusted to the oil/mining revenues arising from abnormally high or low prices.

Conclusion and Policy Implications Monetary policy, an effective monetary institution with a real autonomous of the central bank in terms of policy and operations No fiscal interference resulting to a pro-inflation bias. A credible inflation targeting (IT) regime which goes in peer with an independent monetary institution is a commitment device that could facilitate to the later to deliver the objective of price stability for WAMZ Countries. Ghana lesson: not a significant successful so far: the credibility of the monetary policy regime such as the IT should start from a credible fiscal rule and an effective coordination between fiscal and monetary policy. An effective monetary policy regime is accompanied by an active fiscal rule that can delivers fiscal solvency IT effectiveness as an indicator of Emerging Economy? See IT : Ghana vs Other Em. Countries