Fiscal Limits, External Debt, and Fiscal Policy in Developing Countries

Huixin Bi, Wenyi Shen and Susan Yang

No 2014/049, IMF Working Papers from International Monetary Fund

Abstract: This paper studies fiscal policy effects in developing countries with external debt and sovereign default risks. State-dependent distributions of fiscal limits are simulated based on macroeconomic uncertainty and fiscal policy specifications. The analysis shows that expected future revenue plays an important role in the low fiscal limits of developing countries, relative to those of developed countries. External debt carries additional risks since large devaluation of the real exchange rate can suddenly raise default probabilities. Consistent with majority views, fiscal consolidations are counterproductive in the short and medium runs. When an economy approaches its fiscal limits, government spending can be less expansionary than in a low-debt state. As more revenue is required to service debt in a high-debt state, higher tax rates raise the economic cost of increasing consumption, reducing the fiscal multiplier.

Keywords: WP; government spending; risk premium; terms of trade; fiscal limits; fiscal policy; sovereign default risk; external debt; developing countries; state-dependent fiscal multiplier; debt state; government spending effect; government spending multiplier; exchange rate; government spending share; debt distribution; fiscal policy effect; government spending shock; Government consumption; Fiscal consolidation; Eastern Europe (search for similar items in EconPapers)
Pages: 37
Date: 2014-03-31
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Citations: View citations in EconPapers (15)

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