Fiscal Policy
Introduction
What is fiscal policy?
Decisions by the national government regarding the nature, level and composition of
government expenditure, taxation and borrowing, aimed at pursing particular goals
Macroeconomic focus: Manipulation of government spending, taxes and the deficit
before borrowing in order to pursue macroeconomic policy goals.
What makes it interesting?
Size of fiscal policy in SA – Government expenditure is 1/3 of GDP, this means they
need to generate revenue and also borrow in order to finance this expenditure.
There is a difference between fiscal and monetary policy in terms of politics.
Monetary policy is partially independent from political interference.
o It is goal dependent and instrument independent (government can’t influence
day to day decisions of reserve bank).
o There is a constitutional attempt to minimise interaction between policy and
politics.
Fiscal policy – this is political through and through
o Need political and technical skills.
Need to sell policies to colleagues and other departments.
Can fiscal policies work in a democracy?
o Karl Marx: “Democracy cannot survive because as soon as people learn they
have a voice in fiscal policy, they will vote for themselves and take all the
money from the treasury and bankrupt the nation.”
o Wrong!
Who are the fiscal policy makers?
o Press: Minister of Finance – makes lots of public statements.
o National treasury – DG of treasury (head of dept), leading economist of
department.
o Director of tax policy – also NB roles.
o Who actually makes the decisions? Technically all parties are fiscal parties
are authorities:
Fiscal policy authorities:
Ministry of Finance
National Treasury
SA Revenue Services
SA Reserve Bank ((Issuing of debt and trading of debt
instruments – NB for financing gov. expenditure)
Parliament
Other NB influences:
Political parties, private sector (representations to
government), IMF, etc..
1
Megan Friday 19026692
, Key Relationships for how fiscal policy making plays out:
o President supportive of fiscal policies? (Head of government and fiscal
authorities)
NB relationship for implementation of policies
o Ruling political party and fiscal authorities
o Minister of Finance and cabinet colleagues
o Minister of Finance and Technocrats
Officials in dept. if there is a loyalty – easier to make good fiscal policy
and implement it.
In SA in our parliamentary system, the likelihood of conflict is fairly slight. But in the
US, it is likely that the President is from one side, and the cabinet from another (i.e
republicans vs democrats).
Macro-level instruments:
o Government spending
o Tax revenue
o Budget deficit All decisions by policy
o Financing the deficit members add up to impacting
Micro-level instruments: fiscal policy.
o Spending categories
o Types of taxes
o Dimensions of debt
Can the fiscal authorities control fiscal aggregates?
Revenue Treasury can control the tax rates, but revenue is linked to the
economy. I.e if in recession, then the tax revenues fall.
Expenditure Can treasury control government spending? Varies (to some
degree, some components more than others). Departments are
supposed to remain within budgets.
Purchases vs salaries and wages (treasury doesn’t fully control
this). There are negotiations, and often it is higher than what
treasury budgeted for – and this is about 40% of government
spending.
Things they can affect more readily (i.e not buying cars for
ministers – but these are not the large amounts)
Balance Partially (at most.. ). Impact of treasury on the balance is not fully.
Aggregates are usually expressed as percentages as GDP – the deficit may be 3 /
4% of GDP, and on this level, treasury has very little control over actions of gov.
The government
Can define government sector in various ways – has a large effect on …?
2
Megan Friday 19026692
, Central government Government departments
Extra-budgetary institutions
Social security funds
General government Plus: Provincial governments
Local governments
Public Sector Plus: public enterprises and corporations
Can see how much the numbers differ according to different definitions of government.
Sub-module focus areas:
Fiscal policy
o Sustainability
o Stabilisation effect
o Role of policy making institutions
o Current situations in SA
Sustainability
Has a lot to do with level of debt and whether government can continue to service the
debts.
Problem in SA, but also all over the world (developed countries) following heavy
borrowing before and after the financial crisis.
Debt accumulation – people are worried, will they be able to manage debt, and what
does it mean for future generations who will need to deal with large levels of debt.
It was the role of government to stimulate economy and generate economic growth.
Consolidation – the way that government should help cut the deficit of the
government.
Fiscal policymaking institutions
New institutional economics – institutions are the rule of the game.
Better rules make better players – by James Buchannen
o Incentives?
Examples of fiscal policy making institutions
o Numerical rules (I.e EU – rule that deficits limited to 3% of GDP).
o Budget-process rules.
Current situation in SA
Looking at credit ratings (junk rating after
transition), when we re-entered international
markets. This improved ratings steadily, (1990s –
first decade of 2000).
Recently – not a good outlook, two rating
agencies have downgraded us to junk and the
third might follow suite.
Financing of budget deficits
3
Megan Friday 19026692
, Introduction
Topic – sustainability of fiscal policy
All fiscal deficits have to be financed.
In some way need to
Four (legal) options:
ensure markets that you
o Seigniorage – creating money to finance the
can access capital and
budget deficit repay loans.
o Foreign exchange reserves
o Foreign borrowing (international markets)
o Domestic borrowing (local money markets)
There are clear limits to use all four options – at some points government exceed
limits and pay macroeconomic prices.
Options for financing budget deficits
Seigniorage Foreign exchange Foreign borrowing Domestic borrowing
reserves
Associated macroeconomic imbalance
Inflation Balance of External debt crisis Crowding-out
Payments crisis
Historically – Sir Francis Drake returned from circumnavigating the globe, and was
knighted, but en route he played a pirate and stole from Spanish ships – enough gold
to fund the monarch for a year (dangerous way to finance budget deficit).
Seigniorage
Revenue obtained from money creation to finance a deficit
o Mechanism : government sells bonds to central bank
o Possible to do this without causing inflation
When does it become an unsustainable option
o There is a very limited scope for financing government balance deficit in this
way.
Determinants:
o Rate of economic growth
o Demand for base money (currency and ST deposits)
o Elasticity of demand for real balances with respect to income and inflation
Practical examples:
o Assumptions, income elasticity of demand for real balances = 1
o Assume that the ratio of base money to GNP is 13%.
o Then argue that if GNP / GDP increases by 1%, the government can obtain
0.13 percentage points of GNP in revenue
Print money to meet demand for real balances.
Beyond this point, the risk of inflation becomes larger.
But as the rate of inflation increases, the demand for base money falls.
More and more money printing required to obtain a particular level of seigniorage
revenue as you had before (inbuilt reliance on not using seigniorage).
Countries using this often – leads to hyper-inflation.
4
Megan Friday 19026692
Introduction
What is fiscal policy?
Decisions by the national government regarding the nature, level and composition of
government expenditure, taxation and borrowing, aimed at pursing particular goals
Macroeconomic focus: Manipulation of government spending, taxes and the deficit
before borrowing in order to pursue macroeconomic policy goals.
What makes it interesting?
Size of fiscal policy in SA – Government expenditure is 1/3 of GDP, this means they
need to generate revenue and also borrow in order to finance this expenditure.
There is a difference between fiscal and monetary policy in terms of politics.
Monetary policy is partially independent from political interference.
o It is goal dependent and instrument independent (government can’t influence
day to day decisions of reserve bank).
o There is a constitutional attempt to minimise interaction between policy and
politics.
Fiscal policy – this is political through and through
o Need political and technical skills.
Need to sell policies to colleagues and other departments.
Can fiscal policies work in a democracy?
o Karl Marx: “Democracy cannot survive because as soon as people learn they
have a voice in fiscal policy, they will vote for themselves and take all the
money from the treasury and bankrupt the nation.”
o Wrong!
Who are the fiscal policy makers?
o Press: Minister of Finance – makes lots of public statements.
o National treasury – DG of treasury (head of dept), leading economist of
department.
o Director of tax policy – also NB roles.
o Who actually makes the decisions? Technically all parties are fiscal parties
are authorities:
Fiscal policy authorities:
Ministry of Finance
National Treasury
SA Revenue Services
SA Reserve Bank ((Issuing of debt and trading of debt
instruments – NB for financing gov. expenditure)
Parliament
Other NB influences:
Political parties, private sector (representations to
government), IMF, etc..
1
Megan Friday 19026692
, Key Relationships for how fiscal policy making plays out:
o President supportive of fiscal policies? (Head of government and fiscal
authorities)
NB relationship for implementation of policies
o Ruling political party and fiscal authorities
o Minister of Finance and cabinet colleagues
o Minister of Finance and Technocrats
Officials in dept. if there is a loyalty – easier to make good fiscal policy
and implement it.
In SA in our parliamentary system, the likelihood of conflict is fairly slight. But in the
US, it is likely that the President is from one side, and the cabinet from another (i.e
republicans vs democrats).
Macro-level instruments:
o Government spending
o Tax revenue
o Budget deficit All decisions by policy
o Financing the deficit members add up to impacting
Micro-level instruments: fiscal policy.
o Spending categories
o Types of taxes
o Dimensions of debt
Can the fiscal authorities control fiscal aggregates?
Revenue Treasury can control the tax rates, but revenue is linked to the
economy. I.e if in recession, then the tax revenues fall.
Expenditure Can treasury control government spending? Varies (to some
degree, some components more than others). Departments are
supposed to remain within budgets.
Purchases vs salaries and wages (treasury doesn’t fully control
this). There are negotiations, and often it is higher than what
treasury budgeted for – and this is about 40% of government
spending.
Things they can affect more readily (i.e not buying cars for
ministers – but these are not the large amounts)
Balance Partially (at most.. ). Impact of treasury on the balance is not fully.
Aggregates are usually expressed as percentages as GDP – the deficit may be 3 /
4% of GDP, and on this level, treasury has very little control over actions of gov.
The government
Can define government sector in various ways – has a large effect on …?
2
Megan Friday 19026692
, Central government Government departments
Extra-budgetary institutions
Social security funds
General government Plus: Provincial governments
Local governments
Public Sector Plus: public enterprises and corporations
Can see how much the numbers differ according to different definitions of government.
Sub-module focus areas:
Fiscal policy
o Sustainability
o Stabilisation effect
o Role of policy making institutions
o Current situations in SA
Sustainability
Has a lot to do with level of debt and whether government can continue to service the
debts.
Problem in SA, but also all over the world (developed countries) following heavy
borrowing before and after the financial crisis.
Debt accumulation – people are worried, will they be able to manage debt, and what
does it mean for future generations who will need to deal with large levels of debt.
It was the role of government to stimulate economy and generate economic growth.
Consolidation – the way that government should help cut the deficit of the
government.
Fiscal policymaking institutions
New institutional economics – institutions are the rule of the game.
Better rules make better players – by James Buchannen
o Incentives?
Examples of fiscal policy making institutions
o Numerical rules (I.e EU – rule that deficits limited to 3% of GDP).
o Budget-process rules.
Current situation in SA
Looking at credit ratings (junk rating after
transition), when we re-entered international
markets. This improved ratings steadily, (1990s –
first decade of 2000).
Recently – not a good outlook, two rating
agencies have downgraded us to junk and the
third might follow suite.
Financing of budget deficits
3
Megan Friday 19026692
, Introduction
Topic – sustainability of fiscal policy
All fiscal deficits have to be financed.
In some way need to
Four (legal) options:
ensure markets that you
o Seigniorage – creating money to finance the
can access capital and
budget deficit repay loans.
o Foreign exchange reserves
o Foreign borrowing (international markets)
o Domestic borrowing (local money markets)
There are clear limits to use all four options – at some points government exceed
limits and pay macroeconomic prices.
Options for financing budget deficits
Seigniorage Foreign exchange Foreign borrowing Domestic borrowing
reserves
Associated macroeconomic imbalance
Inflation Balance of External debt crisis Crowding-out
Payments crisis
Historically – Sir Francis Drake returned from circumnavigating the globe, and was
knighted, but en route he played a pirate and stole from Spanish ships – enough gold
to fund the monarch for a year (dangerous way to finance budget deficit).
Seigniorage
Revenue obtained from money creation to finance a deficit
o Mechanism : government sells bonds to central bank
o Possible to do this without causing inflation
When does it become an unsustainable option
o There is a very limited scope for financing government balance deficit in this
way.
Determinants:
o Rate of economic growth
o Demand for base money (currency and ST deposits)
o Elasticity of demand for real balances with respect to income and inflation
Practical examples:
o Assumptions, income elasticity of demand for real balances = 1
o Assume that the ratio of base money to GNP is 13%.
o Then argue that if GNP / GDP increases by 1%, the government can obtain
0.13 percentage points of GNP in revenue
Print money to meet demand for real balances.
Beyond this point, the risk of inflation becomes larger.
But as the rate of inflation increases, the demand for base money falls.
More and more money printing required to obtain a particular level of seigniorage
revenue as you had before (inbuilt reliance on not using seigniorage).
Countries using this often – leads to hyper-inflation.
4
Megan Friday 19026692
