1. 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

2. 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?

3. 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)

4. 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

5. 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”

6. 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

7. 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

8. 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.

9. 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

10. 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)).

11. Public Liabilities and Primary Balance in the WAMZ

12. Public Liabilities and Primary Balance in the WAMZ

13. Public Liabilities and Primary Balance in the WAMZ

14. Model Specification, Data and Estimation Methodology
VAR system of vector 𝑧 𝑡 = 𝑝𝑏 𝑙𝑖𝑎𝑏 ′
𝑧 are observed annually 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

15. Model Specification, Identification and Estimation
Δ 𝑍 𝑡 = 𝑐+ 𝑗=1 𝑝 𝑅 𝑗 Δ 𝑍 𝑡− 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 = 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

16. Empirical Results

17. Empirical Results

18. Empirical Results

19. Empirical Results

20. Empirical Results

21. 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

22. 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

23. 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 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 resulting to Gambia been assessed in 2016 as being at high risk of debt distress.

24. 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

25. 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.

26. 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