Fiscal Crises

Abstract

A key objective of fiscal policy is to maintain the sustainability of public finances and avoid crises. Remarkably, there is very limited analysis on fiscal crises. This paper presents a new database of fiscal crises covering different country groups, including low-income developing countries (LIDCs) that have been mostly ignored in the past. Countries faced on average two crises since 1970, with the highest frequency in LIDCs and lowest in advanced economies. The data sheds some light on policies and economic dynamics around crises. LIDCs, which are usually seen as more vulnerable to shocks, appear to suffer the least in crisis periods. Surprisingly, advanced economies face greater turbulence (growth declines sharply in the first two years of the crisis), with half of them experiencing economic contractions. Fiscal policy is usually procyclical as countries curtail expenditure growth when economic activity weakens. We also find that the decline in economic growth is magnified if accompanied by a financial crisis.

Predicting Fiscal Crises

“…Avoiding fiscal crises is also important because it has implications for economic growth and the development agenda. Fatas and Mihov (2013) showed that volatile fiscal policy lowers economic growth, and work by Gerling et al (2017) suggests fiscal crises can have long-term implications for GDP per capita. As such, it is important to understand what may be causing the crises and how to avoid them.…”

“…The literature on fiscal crises and on early warning indicators is limited, although it has expanded in recent years. Most of the past literature focused on sovereign external debt defaults alone, although more recent papers (Gerling et al, 2017) have looked at more comprehensive definitions of fiscal crises, including access to official financing and implicit domestic default (high inflation). There is also a growing interest in leading indicators of fiscal crises (or fiscal distress), partly motivated by the global financial crises.…”

Sovereign External Borrowing and Multilateral Lending: Dynamics and Crises

“…To analyze the behavior of capital flows around fiscal crises, the analysis uses the database of fiscal crises prepared by Gerling et al (2017). Those authors define fiscal crises as periods of extreme funding difficulties that result in a disruption in the normal debt dynamics and in the 13 Public and publicly guaranteed multilateral loans include loans and credits from the World Bank, RDBs, and other multilateral and intergovernmental agencies.…”

“…The threshold for emerging markets and low-income developing countries is 100 percent. Finally, a loss of market confidence crisis occurs in years of extreme market pressures, when either the country loses market access 22 or the price of market access surpasses a threshold of 1,000 basis points for the spreads, which is widely seen as market participants' psychological barrier (Gerling et al, 2017).…”

“…The second strand of the literature looks at the procyclicality of fiscal policy. A vast body of empirical literature has found that fiscal policy is procyclical for developing and middle-to-highincome countries, reinforcing the business cycle further, and harming the economy when conditions are already critical (Végh, Lederman, and Bennett 2017;Gerling et al 2017;Bova, Carcenac, and Geurguil 2014;Frankel, Végh and Vuletin 2013;Reinhart and Reinhart 2008;Ilzetski and Végh 2008;Alesina, Campante, and Tavellini 2008;Talvi and Végh 2005;Kaminsky et al 2005;Tornell and Lane 1999;Gavin and Perotti 1997;Cuddington 1989). Multiple factors can explain this behavior, including political economy distortions and the quality of governments (Avellán and Vuletin 2015;Ilzetski and Végh 2008;Talvi and Végh 2005;Tornell and Lane 1999).…”