Essays in Honour of J. George Waardenburg
Edited by Servaas Storm and C. W.M. Naastepad
Chapter 6: The many edges of the fiscal policy sword
6. The many edges of the ﬁscal policy sword C.W.M. Naastepad* 1. INTRODUCTION Macro- as well as microeconomic theory have pointed to positive relations between the government budget deﬁcit and inﬂation, and between the budget deﬁcit and the trade balance. With these positive relations in mind, governments have, under various programmes, committed themselves to reduce their budget deﬁcits in order to keep inﬂation and trade deﬁcits under control. This has happened most notably in programmes of stabilization and structural adjustment in developing countries. The experience with programmes of stabilization and structural adjustment in developing countries, however, shows that in many cases these policies have been accompanied by major declines in private investment and growth; nor have they everywhere succeeded in restoring price stability and in reducing current account deﬁcits (Corbo and Fischer, 1995; Rodrik, 1995). This paper suggests that the reason for such failures may have to be sought in the negative impact of deﬁcit reductions on the supply of credit as well as on ‘real’ supply. Monetized deﬁcit reductions, which typically form the core of an adjustment programme, involve a monetary squeeze which may result in shortages of credit. If credit is used to ﬁnance working capital as well as investment, credit shortages may result in a reduced supply of goods and services in the short as well as medium run. In addition, when public investment is complementary to private investment, deﬁcit reductions achieved through a curtailment of public...
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