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Optimal Debt Management with a Stability and Growth Pact

Submitted by puput on Fri, 08/13/2010 - 03:06

This paper examines how the public debt should be managed to minimize the risk that the budget deficit exceeds the 3% limit of the Stability and Growth Pact. This requires to choose debt instruments which provide flexibility to fiscal policy; which create room in the budget for the automatic stabilizers or counter cyclical fiscal policy to operate. The idea is that the maturity and the indexation of public debt can be used to hedge against inflation and output shocks to the budget, so as to stabilize the deficit to GDP ratio. The optimal debt composition would depend on the correlations between output, inflation and interest rates. For instance, if interest rates and output are negatively correlated, then a long maturity debt would insulate the government budget from interest rate shocks, thus avoiding higher than expected interest payments at times of cyclical downturns. The choice of indexation of public bonds to the inflation rate or to GDP can also be examined within this framework. For instance, inflation indexed debt could be a useful hedge since deflation worsens the budget as a consequence of several nominalistic features of the tax system and spending programs.

The idea of the paper follows from the optimal taxation literature on debt man agement stemming from Lucas and Stokey (1983), extended by Bohn (1988,1990) and Barro (1995) and reviewed in Missale (1997). The main insight of this literature, that debt instruments provide insurance against macroeconomic shocks to the budget, and thus allow to smooth taxes across time and states of nature, is applied here to a situation where the constraint imposed by the Stability and Growth Pact induces a greater attention to insuring against current unfavorable events as opposed to tax smoothing over the future ahead. Specifically, the Pact introduces deficit stabilization (or deficit smoothing) as a new objective of debt management. This is formalized by a simple three period model where the government trades off the cost of exceeding the 3% deficit limit against the costs of fiscal correction. The budget is affected by cyclical conditions, namely by output and inflation, while an increase in interest rates leads to higher debt servicing costs on the part of the debt which has a short maturity. The government chooses between short and long term conventional debt and on inflation indexed debt, before any shock realizes, while it decides the fiscal correction after observing output, inflation and the interest rate. However, the effect of fiscal policy remains uncertain since the budget is hit by a random shock.

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Ebook Immigration, Ethnic Wage Differentials and Output Pay: Canadian Evidence from the WES

Submitted by puput on Tue, 03/30/2010 - 01:58

New immigration patterns and the growing diversity of the Canadian population have generated important policy debates. At the heart of these debates are questions over the extent to which public and private institutions have responded to the changing face of Canadian society. Nowhere are these questions more apparent than in the significant barriers faced by visible minority groups in the labour market (Bloom et al. 1995; Statistics Canada 2003b). Indeed, a recent study by the Conference Board of Canada finds that visible minorities earn 14.5 per cent less than other Canadians (Conference Board of Canada 2004). This difference raises serious issues regarding constitutional rights, obstacles to economic growth and the concentration of social problems such as poverty, unemployment, and social alienation. This paper employs Statistics Canada's Workplace and Employee Survey (WES) to examine the impact of ethnicity on earnings after accounting for the method of pay, minority language, and immigrant status.

Fang and Heywood (2006) were the first to examine the association between payment method and ethnic wage differentials in Canada. Building on earlier research, they hypothesize that output pay tying earnings to productivity, makes it harder for employers to discriminate in earnings than do time rates in which earnings are often determined, in part, by supervisory discretion. Their earnings equation estimates from the 1999 WES confirm that ethnic wage differentials are significantly different from zero in the time rate sector but are nonexistent in the output pay sector. While their Canadian evidence confirms similar findings from other countries (reviewed in the next section), it does not account for the particularly high correlations in Canada between immigrant status, language skills and ethnicity.

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Ebook Elections, Macroeconomic Preferences and International Financial Market Constraints

Submitted by puput on Mon, 07/26/2010 - 03:33

Despite the strong pressures from international financial markets on governments’ ability to choose freely among different economic policy options, political parties, at least nominally, continue to offer very distinct policy solutions. Parties, when running for office, often pretend that they will implement economic policies that differ significantly from those of their competitors and sometimes also succeed in convincing voters that they in fact will do so. Distinct nominal party positions in economic policy thus still is an important component of democratic electoral competition, while, at the same time, many observers object that government parties pursue very similar actual economic policies once they assume office.

Although the strategic positioning of parties is not surprising and the concern that parties may implement different policies than those proposed during a campaign is not novel, it is difficult to assess systematically to what extent this is the case, and how it has changed during the past decades. Moreover, a popular, alternative proposition states that governments diverge instead of converge in their economic policies. This is because demands for redistribution increase when rich people and firms (generally) benefit from increasing openness, while poorer citizens and workers are exposed to greater uncertainty. How the relationship between nominal economic positions and actual policies in industrialized countries has developed during the past decades thus is not clear from a theoretical point of view.

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