Fiscal Multipliers and the Home Bias of Public Debt

Comments by Martin Weale

August 2016

• Does the impact of a budget deficit depend on whether it is financed at home or abroad?

• Home bias to holding is strongest in Japan.

• More than half of public French and German debt is held abroad.

• Home bias is perhaps less pronounced in the euro area than in other countries.

• Currency bias and home bias.

• Growth depends on lagged growth and change in the cyclically adjusted primary balance or narrative fiscal shock.

Model

• An endowment is received period 0 which can be invested in capital (what else can be done with it?).

• The capital can be pledged (to foreigners?)

• In period 0 the endowment plus the capital pledged to foreigners can be used to buy fixed capital or public debt with a fixed home bias.

• In period 1 c=rk+w+lb-x-t

• In period 0 k+lb=w+x • In period 1 c=rk+w+lb-x-t • Consumption is factor income plus domestic

holdings of government debt less capital pledged abroad and taxes

• Or c=rk+w-t+w-k • Consumption is factor income less taxes plus

endowment less capital stock. • Is the capital saved up for a period 2 which is not

described?

• The government invests in period 0 by issuing debt.

• In period 1 it collects the taxes to pay the debt.

• Government debt is assumed to be at zero real interest rate. Would a negative rate be more realistic? The marginal product of capital is positive and it is simplest to assume that this equals the interest rate on government debt.

• In a closed economy an increase in g means less k so the impact on output is the output delivered by extra g less the marginal product of capital.

• In an open economy which is not fully borrowed an increase in g is financed from abroad with no reduction in k and so no loss of output

• If the capital stock is fully pledged, then there is some loss, increasing in the home bias of financing and in the share of capital which can be pledged to foreigners

• Below the point where constraints start to bite borrowing from abroad seems costless.

• But this may represent what happened in the euro area before the crisis- Greece

• The same would of course be true of private borrowing- e.g. the Irish Republic

• If only

• The model does not in fact assume that debt is never repaid so why does this result arise.

• As though the focus is on output rather than income.

• With a fixed labour supply foreign finance raises output but the marginal product owned by foreigners accrues to foreigners.

• The impact on income is g-f’(k) just like the effect of domestic finance in this model

• The model tries to arbitrage the difference between GDP and GNP. With fixed labour GNP is more relevant and the theoretical result then disappears.

• What would happen with country fixed effects as well as with year dummies?

• When does borrowing from abroad make you rich?

• Some explanation is needed of why not all of the marginal product of capital accrues to the investors.

• In the Mundell-Fleming model a budget deficit would lead to higher demand and a higher real exchange rate raising supply. So GDP/GNP would increase.

• In the euro area cost imbalances built up despite the single market.