Fiscal Policy Issues

Given the unprecedented collapse of real economic activity, and the awareness that further monetary easing was either infeasible or constrained, many governments in the region resorted to aggressive easing of fiscal policy. The fiscal positions deteriorated sharply in these countries from 2007 to 2008, and further in 2009 (Figure 3 [ PDF 284.2KB | 1 page ]). Of course, not all of the fiscal deterioration was due to the introduction of a fiscal stimulus package, as automatic stabilizers also kicked in. It is not easy to estimate the size of the fiscal packages, net of the automatic stabilizers, and the spending or tax reduction measures that had already been planned. To complicate matters further, the announced spending increase in some cases also included prospective contributions from the private sector and may even include an amount which will never be implemented in the end. With this caveat, the announced fiscal stimulus packages ranged widely across the region, from less than 1% to over 10% of GDP.

The PRC had a particularly large fiscal package, mainly concentrated in public investment. Given the comfortable fiscal space it enjoyed, the PRC government quickly expanded public investment in key infrastructure while cutting taxes. More than 85% of the CNY4 trillion stimulus package announced in early November 2008 (amounting to some 16% of GDP) was accounted for by investment spending. Coupled with the impact of monetary easing, the PRC's fiscal expansion appears to have helped support the country's economic recovery in early 2009. Japan also had a large fiscal package, although the country's fiscal space was limited by the chronic fiscal deficits that had raised the level of debt to over 200% of GDP. India was another country that eased fiscal policy when the fiscal space was rather limited (with the balance of public debt exceeding 80% of GDP). With the state budgets included, India's general government deficit is expected to reach 10% of GDP in 2009, though some of the increase in government spending reflects the increase already implemented before the onset of the crisis.

Estimates of fiscal multipliers vary widely (Horton, Kumar, and Mauro 2009), but it is certain that, regardless of the size of the multiplier, expansionary fiscal policy added to aggregate demand (even though the multiplier may well have been one or less than one). The resurgence of fiscal activism, long disowned by the economic profession, has presented an occasion to reflect upon the countercyclical use of fiscal policy. In the context of Asia, a large share of fiscal expansion fell on infrastructure, which entailed implementation problems, given lags and capacity limitations. Not all investment projects can be profitable, and some may well lead to corruption. This led some in participants at ADBI's macroeconomic policy conference to argue that more should have been done on the revenue side, both because the impact of a tax cut is more immediate and because tax reform can be a way of removing distortions in the economy. Empirically, however, it is well understood that the multiplier of a tax cut is typically much smaller than that of an increase in spending.

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