1. Government Spending & Fiscal Policy Presented by: Zahra Abdulkadir Amin

2. CONTENTS  Government Spending  Government Deficit  Adjusting the deficit for inflation & the cycle  Government Deficit and the national debt  The stance of fiscal policy  Applications on Kuwait

3. The scale of government spending  Spending by the government can be classified into five main categories: 1- Consumption 2- Current grants & subsidies 3- Debt Interest 4- Fixed Investment 5- Capital Transfers  Only Government consumption & Fixed investment enter the GDP. The rest are transfer payments that do not form parts of the GDP.

4.  Transfer payments are a redistribution of income & are non- exhaustive to the economy.  Capital transfers are received by businesses as grants.  Debt interests are received as income by individuals or institutions.  The ratio of government consumption to GDP is used to assess the quantity of resources used by the government. %

5.  When measured using constant and current prices, the ratio of government expenditures to GDP exhibit different fluctuation rates.  The price of government consumption has risen faster than the GDP deflator.  The reason for that is that it’s difficult to measure improvements in the quality of government services.  Improvements are thus measured by the government spending, by adding up the resources used, which fails to reflect the productivity growth.

7.  Government investments in the UK roughly halved remaining very law since the 1970s.  The fall in government investment happened because the government was obliged to reduce its spending.  Government spending changes not only as a response to changes in economic policy, but also as a response to structural changes in the economy.

8. THE GOVERNMENT DEFICIT Measuring the deficit  GD = Total government spending - Taxation.  Either the central government, all government or the whole public sector is included.  The two most important measures are : the Public Sector Financial Deficit (PSFD) and the Public Sector Borrowing Requirement (PSBR). 1- Public Sector Financial Deficit  Used when we focus on the public sector as a whole. It comprises government spending less income, plus the deficit of public corporations.

9. Public Sector Borrowing Requirement  When negative, it’s referred to as the Public Sector Debt Repayment (PSDR).  The difference between the PSFD and PSBR is the ‘net lending to the private sector and overseas’. This includes net purchases of company securities.  When public corporations are privatized, NL includes the proceeds of privatization (revenues) which make it large and negative. PSBR= PSFD+ Net Lending

10. Observing those two graphs we notice:  1960s: The deficit was small using both measures. A small surplus was then achieved in 1969- 1970.  1970-1974: the deficit rose enormously.  Both measures have fallen greatly since 1983.  The gap between the two increased due to the massive rise in privatization proceeds. £ Billion

11. Why does the government deficit matter?  If it’s not financed by an increase in money supply, it must be financed by borrowing.  Large scale borrowing raises interest rates causing the crowding out effect.  How to finance the deficit depends on the public view of shares and bonds.

12. Extreme Cases of the Public View Case A  Equities as riskier than government bonds & a risk premium is required.  Either using equities or bonds, interest rates will be raised by just much and rates will rise and fall together keeping RP constant.  The best measure in this case is the PSFD. Case B  Equities are different from bonds.  Issuing equity has no effect on the price of bonds & interest rates.  The focus is on PSBR.  Prices of equities, however, are affected & thus Tobin's q.

13. Adjusting for inflation and the cycle Government deficit needs to be adjusted for the following: 1- Inflation tax  Inflation tax is the economic disadvantage suffered by holders of cash and its equivalents due to the effects of inflation.  Since government are the biggest debtors, inflation tax transfers resources from the private sector to the government.  Only the real cost of interest payments should.

14. Business Cycle  A business cycle represents economy- wide fluctuations in production over a long period of time.  Even without any change in government policy, the deficit varies over the cycle.  The cyclical adjustment can be calculated creating the cyclically corrected deficit.  This is the deficit that would occur given full employment, lower benefit payments and higher tax revenues.

15.  The structural PSFD shows a deficit in 1970s.  1970s: The inflation adjusted PSFD shows a surplus.  During the 1980s a deficit emerged due to the fall of inflation reducing the inflation tax.  Main Causes: the large rise in unemployment & the fall in output, reducing the effect of the contractionary policy.

16. Calculating the Inflation Tax  Inflation makes debtors better off and creditors worse off.  Inflation tax can be calculated as: Where NML= Nominal Government's net monetary liabilities.  If r= average nominal interest rate on government bonds, & r.NML=nominal interest payments then, Real Interest Payments= Nominal Interest Payment- Inflation Tax π.NML (r-π).NML= r.NML- π.NML

17.  Inflation changes yearly.  Calculating the inflation tax using the actual inflation rate can vary greatly.  An inflation rate based on a longer term should be used, called the expected inflation rate.  The same measure should apply to interest rates.  An ex ante inflation tax can be calculated using expected interest rates.

18. Interest payments  It’s argued that government deficits raise interest payments.  The real measure of the cost of debt should be considered.  Throughout the 1970s real interest payments were negative.  The real burden of interest rates increased sharply since 1980s. THE GOVERNMENT DEFICIT AND THE NATIONAL DEBT

19. Government Debt Note that:  It’s possible to run a deficit without the real value of the debt increasing if inflation is reducing its real vale.  Real Debt will increase only if the inflation-adjusted balance is negative.  If GDP grows at a rate of 12%, the government can run a deficit of 12% of the national debt each year.

20.  If the growth rate of GDP (g) exceeds the real interest rate in the long run, the ratio of government debt to GDP will converge to a stable equilibrium.  1960s: National debt fell as a proportion of GDP and since then has been approximately constant.  The ratio of debt to GDP is self limiting.

21.  Real deficit is divided into two parts; the primary deficit and real interest payments: γGDP+ (r-π) Debt  Dividing by total debt, we obtain the growth rate of the debt: =(γGDP+ (r-π) Debt)/Debt =γ(GDP/Debt)+ (r-π)  The ratio of debt/GDP will be constant if they grow at the same rate, thus: γ(GDP/Debt)+ (r-π) = g From this, it follows that: Debt/GDP= γ/(g-r-π) DYNAMICS OF DEBT AND DEIFICTS

22. CONCLUSIONS: THE SATANCE OF FISCAL POLICY  Government deficit is the best measure of the stance of the fiscal policy. However,  Spending & Taxation affect the level of aggregate demand independently of the size of the deficit (balanced budget multiplier theorem).  Different types of spending or taxation have different multiplier affects.  The way in which a deficit is financed affects the level of aggregate demand.

23. Applications on Kuwait

24. Government Spending, 2007/2008 By Chapter By Economic Scale

25. Consumption Investment Real Nominal

27. Government Expenditures Trend by Chapter

28. Financial Year 2007/2008 BudgetActualDiff. Revenues (Million KD) Oil & Gas 7,450 17,719 10,269 Non Oil Revenues 870 1,304 434 Total Revenues 8,320 19,023 10,703 Expenses (Million KD) Salaries 2,626 2,477 (149) Services & Commodities 1,834 1,768 (66) Transport & Equip. Installations 216 90 (126) Construction & Maintenance 2,058 1,206 (852) Others and transfer payments 4,567 4,157 (410) Total Expenses (Million KD) 11,300 9,698 (1,602) Future Generation Reservation 832 1,903 1,071 Commitments & Expenses 12,132 11,600 (532) Budget Surplus/Deficit (3,812) 7,422 3,610

29. DETERMINING GOVERNMENT EXPENDITURE MODEL The government expenditures model can be formulated as: G(t)=  +  Y+  G(t-1)+  Where G(t) is total government expenditures at time t, Y: real output G(t-1) is government expenditures of the previous year and  is the error term. Using those parameters, the results obtained for Kuwait for the period 1994-2007, is: G(t)=-2890 +0.55Y+ 0.20 G(t-1)

30. SUMMARY OUTPUT Regression Statistics Multiple R0.95 R Square0.90 Adjusted R Square0.88 Standard Error757.81 Observation s14.00 ANOVA dfSSMSF Significance F Regression2.0055925117.4927962558.7448.690.00 Residual11.006316983.10574271.19 Total13.0062242100.59 Coefficients Standard Errort StatP-valueLower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept-2889.911008.71-2.860.02-5110.06-669.75-5110.06-669.75 X Variable 10.550.153.770.000.230.880.230.88 X Variable 20.200.250.810.43-0.350.76-0.350.76

32. Estimating the Government Consumption Expenditures Model C(t)=  +  Y+  C(t-1)+  R+  Where C(t) is the government consumption expenditures, Y the real level of output, R is reserve money, C(t-1) is consumption expenditures of the previous year and  is the error term. Estimating the model, the result obtained is: C(t)=-457 +0.04 Y+ 0.97 C(t-1)+ 0.14R The log form can be taken to estimate the elasticities of the involved parameters, such that: Log C(t)=  +  Log Y+  Log C(t-1)+  Log R +  Resulting in: C(t)= -0.51 + 0.17Y+ 0.91C(t-1)+ 0.05R+ 

33. SUMMARY OUTPUT Regression Statistics Multiple R0.99 R Square0.98 Adjusted R Square0.97 Standard Error123.05 Observations14.00 ANOVA dfSSMSF Significance F Regression3.006534244.342178081.45143.840.00 Residual10.00151420.6615142.07 Total13.006685665.01 Coefficient s Standard Errort StatP-valueLower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept-456.54224.06-2.040.07-955.7942.71-955.7942.71 X Variable 10.040.050.730.48-0.080.16-0.080.16 X Variable 20.970.293.370.010.331.620.331.62 X Variable 30.140.081.770.11-0.040.32-0.040.32

34. SUMMARY OUTPUT (Log Form) Regression Statistics Multiple R0.98 R Square0.97 Adjusted R Square0.96 Standard Error0.02 Observations14.00 ANOVA dfSSMSF Significance F Regression3.000.110.04108.350.00 Residual10.000.00 Total13.000.12 Coefficient s Standard Errort StatP-valueLower 95%Upper 95%Lower 95.0%Upper 95.0% Intercept-0.510.25-2.020.07-1.070.05-1.070.05 X Variable 10.170.270.630.54-0.430.76-0.430.76 X Variable 20.910.293.100.010.261.560.261.56 X Variable 30.050.031.590.14-0.020.13-0.020.13