Effects of fiscal policy in Asian Countries

By

Acknowledgement

I would take this opportunity to thank my research supervisor, family and friends for their support and guidance without which this research would not have been possible.

Table of Contents

CHAPTER 1: INTRODUCTION4

CHAPTER 2: LITERATURE REVIEW6

CHAPTER 3: MACROECONOMIC CONTEXT27

CHAPTER 4: RESULTS AND DISCUSSION29

CHAPTER 5: CONCLUSION33

REFERENCES35

APPENDICES40

Chapter 1: Introduction

With the emergence of the European Monetary Union and the growing interest in the possibility of the same for Asia, there is a resurgent interest in the role of fiscal policy as both an expansionary and stabilization tool for government. The 1997 Asian financial crisis, which left some economies in tatters and revived discussions on pump-priming, as well as Japan's protracted experience of near-zero interest rate in a slumping economy what has been called a liquidity trap - have also highlighted the role that fiscal policy can play. Under a monetary union, stabilizing monetary policy is unavailable to individual countries as a tool to address asymmetric or country-specific shocks. Monetary policy is also pointless in a liquidity trap.

As a result of this resurgent interest, the empirical literature on the topic is growing, employing such tools as structural macro econometric models and (structural) vector auto regression models (VAR). At present, however, bulk of this literature is still concentrated on GECD and EMU countries, a likely offshoot of the relative abundance of available models for these groups of countries. In contrast, there is little empirical literature on fiscal policy effectiveness for the developing countries of Asia, whereas these countries are interesting for the variety of their growth experiences and the differences in the relative size of their governments. This paper is an attempt to fill in some of the gap.

This paper studies the macroeconomic effects of fiscal policy and automatic stabilizers in four developing Asian countries - Bangladesh, China, Indonesia, and the Philippines - by means of structural macro econometric model simulations. The main questions we seek to answer for these countries are: How do fiscal policy shocks affect these economies on a macro scale, specifically how do changes in the fiscal position affect economic growth? What are the transmission channels of the shocks? These include size and the dynamic path of the effects, not only on GDP growth but also on its components. Which kinds of fiscal shocks have the desired property of stabilizing the macro economy? Once found, how effective would these automatic stabilizers be in smoothing out large cyclical downturns in these countries? The paper is organized as follows: Section 2 gives a short review of the relevant literature, as well as describes the method of investigation employed in the paper. Section 3 contains a very short summary of the macroeconomic context, including the fiscal picture, in each of the four countries considered here. Section 4 discusses the simulation results.

Chapter 2: Literature Review

Discussions on the effectiveness of fiscal policy may be divided into two strands, the first strand on discretionary policy and the second on automatic stabilizers. Discussions on discretionary fiscal policy typically focus on fiscal multipliers, which may be ...