Inter-American Development Bank April 23, 2009 The opinions expressed in these comments are the responsibility of the author and do not necessarily represent the view of the IMF or its Board of Directors Discussion Antonio Spilimbergo (IMF and CEPR)

1Outline Context Context Sources of the shocks Sources of the shocks Policy responses Policy responses Design of fiscal policy Design of fiscal policy

2 Global Growth

3 Advanced Countries Causes of the collapse of output: Continued financial crisis. Direct effect of credit crunch Trade Investment Indirect effects Lower wealth Collapsing confidence Wait and see

4 Industrial Activity and Global Trade Have Fallen Very Sharply Merchandise Exports (Annualized percent change of 3mma over previous 3mma) Industrial Production (Annualized percent change of 3mma over previous 3mma) Global IP Global Manf. PMI (sa, RHS) Dec.08 World Nov.08 Advanced Emerging

5 Fall in Stock Markets and Consumer Confidence 1/23 Dec.08 Equities (1/1/2007=100; FTSE) Consumer Confidence (Jan. 2005=100) Lehman Brothers

6 Emerging Economies – Latin America Three Major Shocks: Drop in External Demand; Tighter Credit (External Financing); and Lower Commodity Prices.

7 Emerging Economies Growth Slowed By Falling Exports and Industrial Production Industrial Production (in percent change from a year earlier) Emg. Asia Nov.08 Merchandise Exports (in percent change from a year earlier) Latin America Emg. Asia Latin America Nov.08 Emg. Europe Emg. Europe

8 Which Macroeconomic Policies (do not) work? Export-led is not an option open to the world as a whole. Export-led is not an option open to the world as a whole. The financial nature of the crisis weakens the traditional monetary transmission mechanism. The financial nature of the crisis weakens the traditional monetary transmission mechanism.

9 Role of Fiscal Policy During the Crisis Fixing the financial system. Fixing the financial system. Supporting aggregate demand. Supporting aggregate demand. Attenuating the effects on most vulnerable sectors. Attenuating the effects on most vulnerable sectors.

10 Fiscal Policy Public Spending on Goods and Services Public Spending on Goods and Services Fiscal Stimulus Aimed at Consumers Fiscal Stimulus Aimed at Consumers Fiscal Stimulus Aimed at Firms Fiscal Stimulus Aimed at Firms

11 Public Spending on Goods and Services First, make sure that existing programs are not cut for lack of resources. First, make sure that existing programs are not cut for lack of resources. Second, spending programs, from repair and maintenance, to investment projects delayed, can be (re-)started quickly. Second, spending programs, from repair and maintenance, to investment projects delayed, can be (re-)started quickly. Third, a few high profile programs, with good long-run justification and strong externalities, can also help, directly and through expectations. Third, a few high profile programs, with good long-run justification and strong externalities, can also help, directly and through expectations.

12 To avoid Public sector wage increases should be avoided Public sector wage increases should be avoided not well targeted; not well targeted; difficult to reverse; and difficult to reverse; and similar to transfers in their effectiveness. similar to transfers in their effectiveness.

13 Fiscal Stimulus Aimed at Consumers Three specific factors affect consumption at this juncture: Three specific factors affect consumption at this juncture: decrease in wealth; decrease in wealth; tighter credit constraints; and tighter credit constraints; and high uncertainty. high uncertainty.

14 Fiscal Stimulus Aimed at Consumers Broad based tax cuts? Broad based tax cuts? marginal propensity to consume out of such tax cuts may be quite low. marginal propensity to consume out of such tax cuts may be quite low. if the termination date is credible, the intertemporal incentives implied by such a measure are attractive. if the termination date is credible, the intertemporal incentives implied by such a measure are attractive. the degree of pass-through to consumers is uncertain. the degree of pass-through to consumers is uncertain.

15 Fiscal Stimulus Aimed at Firms Subsidies or measures to lower the tax-adjusted user cost of capital (such as reductions in capital gains and corporate tax rates) are unlikely to have much effect. Subsidies or measures to lower the tax-adjusted user cost of capital (such as reductions in capital gains and corporate tax rates) are unlikely to have much effect. Restructuring procedures with government guarantees on new credit. Restructuring procedures with government guarantees on new credit.

16 Sustainability Concerns Very important Very important Not credible policies undermine the scope of fiscal stimulus. Not credible policies undermine the scope of fiscal stimulus.

17 External Financial Pressures Emg. Sovereign CDS Spreads (index: 7/1/2007=100) Current account surplus or small deficit Current account deficit larger than 5% of 2007 GDP 1/23

18 Industrial Economies (5yr Sovereign CDS; in basis points) 1/23 Selected Europe (5yr Sovereign CDS; in basis points) Rising Concerns Over Fiscal Sustainability Source: Bloomberg, L.P.

19 Sustainability Concerns measures that are reversible or that have clear sunset clauses (e.g., future increases in upper income tax rates); measures that are reversible or that have clear sunset clauses (e.g., future increases in upper income tax rates); implementing policies that eliminate distortions (e.g., financial transaction taxes); implementing policies that eliminate distortions (e.g., financial transaction taxes); increasing the scope of automatic stabilizers that, by their nature, are countercyclical and temporary; increasing the scope of automatic stabilizers that, by their nature, are countercyclical and temporary; providing more robust medium-term fiscal frameworks; providing more robust medium-term fiscal frameworks; strengthening fiscal governance through independent fiscal councils; and strengthening fiscal governance through independent fiscal councils; and improving expenditure procedures to ensure that stepped-up public works spending is well directed to raise long-term growth (and tax-raising) potential. improving expenditure procedures to ensure that stepped-up public works spending is well directed to raise long-term growth (and tax-raising) potential.