Graduate School of Humanities and Social Sciences Faculty of Economics, Saitama University

WHAT ARE THE CONSEQUENCES OF

EXPANSIONARY FISCAL POLICY?

Javkhlan Ganbayar

2023-05-19
UNEXPECTED EXPANSIONARY FISCAL POLICY PLAYED
CRUCIAL ROLE DURING ECONOMIC CRISIS
Fiscal targets were modified to allow for the After providing extraordinary support in
expansionary policy response during hard times. 2020– 21, fiscal policy is returning to normal.

AEs ex US
EMs ex China

LIDC

Emerging markets

Advanced economies

Source: Hall and Sargent 2022 Source: IMF, Fiscal Monitor 2023
 THERE ARE SEVERAL REASONS BEHIND
EXPANSIONARY FISCAL POLICY

Because immediate fiscal

adjustment like tax Countercyclical policy
Based on hope that fiscal increase or spending cut movement is effective for
multiplier is greater than 1 could be more costly for sustaining long-term
the economy in the short economic stability
term
HOWEVER, SOME ECONOMISTS ARGUE THAT GOVERNMENT SPENDING CAN HAVE
DRASTICALLY DIFFERENT EFFECTS THAN CONVENTIONAL KEYNESIAN WISDOM

1. Economic characteristics
2. Crowding out effect on private investment
3. Change in households' behavior about consumption
and savings
4. A decrease in public investment to enable debt service
5. Less fiscal room leading to default
6. Disagreement on positive multiplier effect
 LITERATURE REVIEW
SUPPORTING FISCAL POLICY EFFECTIVENESS AGAINST FISCAL POLICY EFFECTIVENESS

EMPIRICAL STUDIES SHOW MIXED CONCLUSIONS AND LACK OF CONSENSUS AMONG ECONOMISTS
OBJECTIVE OF THIS STUDY IS TO SHED LIGHT ON DEBATE IN
CONSEQUENCES OF EXPANSIONARY FISCAL POLICY

FOCUSING ON :
1. Dynamic Stochastic General Equilibrium
(DSGE) approach

2. Small Open Economy tailored model - case

of Mongolia

3. Disaggregation in fiscal policy tools

(government consumption, investment, transfer, income tax and
consumption tax)
 OVERVIEW OF THE MODEL

The model structure applied in this study is similar to DIGNAR model that for average low-
income countries (Melina et al. (2016)). This model is a real, small open economy model
elaborated with fiscal instruments and a resource fund.

Departing from Melina et al. (2014, 2016, 2017), Pranav et al. (2015), we applied the model with
exogenous fiscal policy shocks.

The model have been applied for public investment scaling up analysis, DSA analysis and
structural reforms. However, there is a research gap in exploring fiscal multipliers of such a wide
variety of the government policy instruments using this structure.
 GENERAL ARCHITECTURE OF THE MODEL
𝑌𝑇− tradable sector

𝑌𝑁𝑇− nontradable sector

𝑌𝑂− mining sector

𝑜𝑝𝑡 𝑟𝑜𝑡
𝐺𝐼 + 𝐺𝑧 + 𝐶 𝐶𝑜𝑝𝑡 +𝐶+ 𝐶𝑟𝑜𝑡
𝐶 ++𝐼𝐼++𝐺𝐺𝐶 + 𝑋 − 𝐼𝑀 = 𝑌
=
𝑌𝑇 𝑓 𝐺
= (𝑘𝑇 , 𝐿𝑇 , 𝑘𝑇 )
+
𝑌𝑁𝑇 = 𝑓 (𝑘 , 𝐿 , 𝑘 𝐺 )
𝑁𝑇 𝑁𝑇 𝑁𝑇
+
taxes

Resource fund 𝑌𝑂 ~ (𝑒𝑥𝑜𝑔𝑒𝑛𝑜𝑢𝑠 𝑝𝑟𝑜𝑐𝑒𝑠𝑠 )

𝑘
− 𝑝𝑟𝑖𝑣𝑎𝑡𝑒 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑓𝑜𝑟 𝑠𝑒𝑐𝑡𝑜𝑟
GOVERNMENT HOUSEHOLDS Rest of World FIRMS
𝐿
− 𝑙𝑎𝑏𝑜𝑟 𝑖𝑛𝑝𝑢𝑡 𝑓𝑜𝑟 𝑏𝑜𝑡ℎ 𝑠𝑒𝑐𝑡𝑜𝑟

𝐺
𝑘𝑇
−𝑝𝑢𝑏𝑖𝑐 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑓𝑜𝑟 𝑏𝑜𝑡ℎ 𝑠𝑒𝑐𝑡𝑜𝑟
 HOUSEHOLDS: ECONOMY CONSISTS OF TWO
TYPES OF HOUSEHOLDS
Households maximize the consumption basket by choosing an optimal
mix of tradable and non-tradable goods subject to total expenditure.

A representative household maximizes lifetime utility flows from

consuming and working subject to its budget constraints

𝜑 − 𝑛𝑜𝑛𝑡𝑟𝑎𝑑𝑒𝑑 𝑔𝑜𝑜𝑑𝑠 𝑏𝑖𝑎𝑠 𝛽 − 𝑠𝑢𝑏𝑗𝑒𝑐𝑡𝑖𝑣𝑒 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑓𝑎𝑐𝑡𝑜𝑟 𝜅 𝑜𝑝𝑡 − 𝑑𝑖𝑠𝑢𝑡𝑖𝑙𝑖𝑡𝑦 𝑤𝑒𝑖𝑔ℎ𝑡 𝑜𝑓 𝑙𝑎𝑏𝑜𝑟
𝜒 − 𝑖𝑛𝑡𝑟𝑎𝑡𝑒𝑚𝑝𝑜𝑟𝑎𝑙 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑠𝑢𝑏𝑠𝑡𝑖𝑡𝑢𝑡𝑖𝑜𝑛 𝑜𝑓 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛
𝜎 − 𝑖𝑛𝑣𝑒𝑟𝑠𝑒 𝑜𝑓 𝑖𝑛𝑡𝑒𝑟𝑡𝑒𝑚𝑝𝑜𝑟𝑎𝑙 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑠𝑢𝑏𝑠𝑡𝑖𝑡𝑢𝑖𝑜𝑛 𝑜𝑓 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛
𝜓 − 𝑖𝑛𝑣𝑒𝑟𝑠𝑒 𝑜𝑓 𝑖𝑛𝑡𝑒𝑟𝑡𝑒𝑚𝑝𝑜𝑟𝑎𝑙 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑠𝑢𝑏𝑠𝑡𝑖𝑡𝑢𝑡𝑖𝑜𝑛 𝑜𝑓 𝑙𝑎𝑏𝑜𝑟 𝑠𝑢𝑝𝑝𝑙𝑦
 FIRMS: ECONOMY HAS THREE TYPES OF FIRMS
Nontraded and traded good firms produce output with the following Cobb– Douglas technology

1−𝛼𝑁 𝛼𝑁 𝛼𝐺
𝑦𝑁𝑇,𝑡 = 𝑧𝑁 𝑘𝑁,𝑡−1 𝐿𝑁,𝑡 𝑘𝐺,𝑡−1

1−𝛼𝑇 𝛼𝑇 𝛼𝐺
𝑦𝑇,𝑡 = 𝑧𝑇,𝑡 𝑘 𝑇,𝑡−1 𝐿 𝑇,𝑡 𝑘𝐺,𝑡−1

𝛼𝑁 − 𝑙𝑎𝑏𝑜𝑟 𝑠ℎ𝑎𝑟𝑒 𝑖𝑛 𝑁𝑇 𝑠𝑒𝑐𝑡𝑜𝑟𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒 𝜅𝑁 − 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑎𝑑𝑗𝑢𝑠𝑡𝑚𝑒𝑛𝑡 𝑐𝑜𝑠𝑡 𝑝𝑎𝑟𝑎𝑚𝑒𝑡𝑒𝑟 𝑖𝑛 𝑁𝑇

𝛼 𝑇 − 𝑙𝑎𝑏𝑜𝑟 𝑠ℎ𝑎𝑟𝑒 𝑖𝑛 𝑇 𝑠𝑒𝑐𝑡𝑜𝑟𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒 𝜅 𝑇 − 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑎𝑑𝑗𝑢𝑠𝑡𝑚𝑒𝑛𝑡 𝑐𝑜𝑠𝑡 𝑝𝑎𝑟𝑎𝑚𝑒𝑡𝑒𝑟 𝑖𝑛 𝑇
𝛼𝐺 − 𝑂𝑢𝑡𝑝𝑢𝑡 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑤𝑟𝑡 𝑝𝑢𝑏𝑙𝑖𝑐 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 Ε𝑦𝑜 − 𝑒𝑥𝑜𝑔𝑒𝑛𝑜𝑢𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑠ℎ𝑜𝑐𝑘
𝑧𝑁, 𝑧𝑇 − 𝑡𝑜𝑡𝑎𝑙 𝑓𝑎𝑐𝑡𝑜𝑟 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝜌𝑦𝑜 − 𝑎𝑢𝑡𝑜𝑟𝑒𝑔𝑟𝑒𝑠𝑠𝑖𝑣𝑒 𝑐𝑜𝑒𝑓𝑓 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑠ℎ𝑜𝑐𝑘
𝛿 − 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑐𝑎𝑝𝑖𝑡𝑎𝑙𝑠
 GOVERNMENT – HAS MANY INSTRUMENTS
Revenue: each period the government total receipts consist of the tax revenues (from
consumption, labor income and capital income), international grants, user-fee,
resources-related royalties. Government can issue debt as such as domestic debt,
external concessional debt and external commercial debt. Revenue from resource
sector.

Expenditure: The government's total expenditures consist of i) government consumption, ii)

public investment, iii) transfers to households, iv) debt service payments, and v) savings in the
resource fund.
𝜏 𝐶 − 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑡𝑎𝑥𝑒𝑠 𝜇 − 𝑢𝑠𝑒𝑟 𝑓𝑒𝑒 𝑓𝑜𝑟 𝑝𝑢𝑏𝑙𝑖𝑐 𝑘 𝑑𝑐 − 𝑒𝑥𝑡𝑒𝑟𝑛𝑎𝑙 𝑐𝑜𝑚𝑚𝑒𝑟𝑐𝑖𝑎𝑙 𝑑𝑒𝑏𝑡
𝜏 𝐿 − 𝑙𝑎𝑏𝑜𝑟 𝑖𝑛𝑐𝑜𝑚𝑒 𝑡𝑎𝑥𝑒𝑠 𝑡 𝑂 − 𝑟𝑒𝑠𝑜𝑢𝑟𝑐𝑒 𝑟𝑜𝑦𝑎𝑙𝑡𝑖𝑒𝑠 𝑓 ∗ − 𝑟𝑒𝑠𝑜𝑢𝑟𝑐𝑒 𝑓𝑢𝑛𝑑
𝜏 𝐾 − 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑔𝑎𝑖𝑛 𝑡𝑎𝑥𝑒𝑠 𝑏 − 𝑑𝑜𝑚𝑒𝑠𝑡𝑖𝑐 𝑑𝑒𝑏𝑡 𝑠 − 𝑟𝑒𝑎𝑙 𝑒𝑥𝑐ℎ𝑎𝑛𝑔𝑒 𝑟𝑎𝑡𝑒
𝑔𝑟 ∗ − 𝑖𝑛𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑜𝑛𝑎𝑙 𝑔𝑟𝑎𝑛𝑡𝑠 𝑑 − 𝑒𝑥𝑡𝑒𝑟𝑛𝑎𝑙 𝑐𝑜𝑛𝑐𝑒𝑠𝑠𝑖𝑜𝑛𝑎𝑙 𝑑𝑒𝑏𝑡 R−𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 𝑓𝑜𝑟 𝑑𝑒𝑏𝑡 𝑖𝑛𝑠𝑡𝑟𝑢𝑚𝑒𝑛𝑡𝑠
 REST OF THE WORLD

The goods market clearing condition and the balance of payment conditions are
played to close the model.

Current account deficit becomes

𝜃 𝑂𝑃𝑇 − 𝑝𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑎𝑑𝑗𝑢𝑠𝑡𝑚𝑒𝑡 𝑐𝑜𝑠𝑡𝑠 𝑎𝑠𝑠𝑜𝑐𝑖𝑎𝑡𝑒𝑑 𝑤𝑖𝑡ℎ 𝑓𝑜𝑟𝑒𝑖𝑔𝑛 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

 MODEL CALIBRATION

• The initial steady states are calibrated to the country specific structural
parameters in year 2022, based on national accounts and fiscal data
gathered from official government databases.
• We borrowed some deep parameters from the past DSGE literatures
tailored in average of developing countries.
• Calibrating the model in this way captures the key features of the economy
using wide range of data on income share of GDP, cost shares, tax rates,
debt and assets etc.
• Model produces yearly outcomes and the simulation horizon runs till 2030.
• Five different fiscal policy options (government consumption, investment,
transfer, income tax and consumption tax) are simulated.
• We use Matlab R2022b, Financial simulation toolbox, Dynare 4.5.6 to run
the model.
MODEL CALIBRATION
 SIMULATION RESULTS
Decision to increase public investment (by 1% of GDP)
❑ $1 increase in government
investment raises GDP by $1.2
❑ Upward shift in trend growth
leads 2 p.p higher Labor
❑ Increased household income
pushes private consumption
higher
❑ Government investment
generates private sector
crowding-out
❑ Fiscal adjustment results 5 p.p
higher public debt (both
domestic and external
borrowing)
❑ Increase in aggregate demand
leads higher imports as well as
current account (CA) deficit
❑ CA deterioration makes pressure
on balance of payment and
adjustment made through
relative prices.
 SIMULATION RESULTS
Decision to increase public consumption (by 1% of GDP)

❑ Increase in government
consumption has crowding-
out effect on both private
investment and private
consumption.
SIMULATION RESULTS
Decision to increase transfer by 1%

❑ Government transfer to
households like “child
money allowance” has
weakest effect on
supporting aggregate
demand and labor.
SIMULATION RESULTS
Decision to reduce consumption tax

❑ Effects of consumption
tax cuts are largest in
supporting private
consumption.

❑ However, with this

policy tool, public debt
grows by largest
amount.
SIMULATION RESULTS
Decision to reduce labor tax

❑ Choice of labor tax has

less negative effect on
private investment.
Comparison
of policy
instruments
 CONCLUSION

This study contributes to the debate on consequences and multipliers of fiscal policy, in the context of
a DSGE model, featuring a rich fiscal policy block and a transmission mechanism for government
spending and tax shocks. We find the multiplier for government spending to be 1.2, which is largest on
impact.

1. Selecting public investment is effective strategy If improving productivity is a main objective of

government.
2. Reducing transfer can be a useful measure if government reforms are intended to support the
labor supply.
3. Reduced consumption tax have the biggest impact if the policymaker seeks to increase private
consumption.
4. Labor tax cut strategy has been successful in promoting private investment.
5. Whenever the government decides to support the private sector, avoid prioritizing government
consumption expenditure as a primary tool.
 CONCLUSION

❑ Policymakers apply different strategies and instruments to achieve economic stabilization

objectives. In practice, policymakers combine a number of policy options to maintain
macroeconomic stability. However, they often face difficulty in understanding responses of each
policy tools in their hand.

❑ The study quantitatively measures consequence of practically common utilized five different types
of policy alternatives – government investment, government consumption, government transfer to
households, consumption tax and labor tax – for a mining dependent, SOE economy, using a
DSGE model.

❑ The model-based policy analysis creates consistent and coherent story of fiscal policy tools’
consequence to the overall economy and supports greater comprehension of transmission
mechanisms of policy tools.
 LIMITATIONS

❑ This study sheds light on analysis of fiscal policy tools in mining export based-SOEs, but it cannot
answer directly to policymakers’ desire to find optimal policy mix, reduce inequality and create
more good jobs.

❑ Research outcome could have shortcomings depending on model assumptions like

responsiveness of fiscal policy, elasticities, tax and investment adjustments those are problematic in
real life of many developing economies.

❑ Effects of tax and spending tools may vary over the business cycle and development stage of the
country which is not deeply studied in this analysis.