FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.

posted on 26 November 2015

Rethinking Development Strategies Fiscal Space

by Dirk Ehnts, Econoblog101

The UNCTAD has a new book on development strategies (free pdf available). There is a section of fiscal space, which is an idea that is discussed quite a lot these days.

Here is a paragraph from that section:

Fiscal space is an essential aspect of the policy space needed by the developmental State (see TDR 2014, chapter VII). Even if governments are allowed to conduct some development policies within the multilateral, regional or bilateral frameworks, they still need to finance them. To that end, strengthening public domestic revenues is key, given that they are more sustainable in the long run than relying on aid or debt, as well as being less subject to restrictions and conditions that hamper policy space.

I think that the crucial thing here is to recognise that even thought government in developing economies can create unlimited amounts of currency, the weakness of the "public domestic revenues" (=taxes) might lead to the problem that every "Peso Queso" created and spent at the margin leads to households converting them at the earliest instance into hard currencies, like USD, CHF, EUR and so on. That would mean that the exchange rate would drop as a result of increased government spending. This also what Warren Mosler, one of the founder of Modern Monetary Theory (MMT), says in the context of the Russian default of 1999:

All throughout this process, the Russian Government had the ABILITY to pay in rubles. However, due to its choice of fixing the exchange rate at level above 'market levels' it was not, in mid August, WILLING to make payments in rubles. In fact, even after floating the ruble, when payment could have been made without losing reserves, the Russian Government, which included the Treasury and Central Bank, continued to be UNWILLING to make payments in rubles when due, both domestically and internationally. It defaulted on ruble payment BY CHOICE, as it always possessed the ABILITY to pay simply by crediting the appropriate accounts with rubles at the Central Bank.

Why Russia made this choice is the subject of much debate. However, there is no debate over the fact that Russia had the ABILITY to meet its notional ruble obligations but was UNWILLING to pay and instead CHOSE to default.

I absolutely agree with Mosler. Now the tricky question for developing countries is: if because of free capital flows and speculators driving the exchange rate up and down the volatility of the exchange rate is too high to attract serious foreign (direct) investment, what can you do? You can protect yourself by piling up USD reserves at the central bank. If in crisis, you can defend your exchange rate from falling "too much" ("undershooting"). In a boom, you can use your own currency to buy foreign currency and hence appreciate your own anyways.

To conclude: developing countries should not have over-valued exchange rates, since a correction might lead to a steep fall in the exchange rate and create lots of inflation (via more expensive foreign goods). This reduces real purchasing power and is surely recessionary. If, in such a situation, government uses fiscal policy it might only deepen the problem. The private sector, once it gets an additional "peso queso", instantly sells it for USD in the expectation of more depreciation to come. And come it will - this is a self-fulfilling prophecy! Government should then increase government spending and taxes in lockstep, which would mean that the fiscal multiplier would be very low. Perhaps a suspension of free capital movement would be the only solution if things are really, really bad. This is not something that never happened to developing economies.

Marc Lavoie in his new "Post-Keynesian Economics - New Foundations" has a table (1.4) with fallacies of composition: when all actors do the same thing, they defeat themselves. Perhaps another fallacy should be added?

>>>>> Scroll down to view and make comments <<<<<<

Click here for Historical Opinion Post Listing

Make a Comment

Econintersect wants your comments, data and opinion on the articles posted.  As the internet is a "war zone" of trolls, hackers and spammers - Econintersect must balance its defences against ease of commenting.  We have joined with Livefyre to manage our comment streams.

To comment, using Livefyre just click the "Sign In" button at the top-left corner of the comment box below. You can create a commenting account using your favorite social network such as Twitter, Facebook, Google+, LinkedIn or Open ID - or open a Livefyre account using your email address.

You can also comment using Facebook directly using he comment block below.

Econintersect Opinion


Print this page or create a PDF file of this page
Print Friendly and PDF

The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.

Take a look at what is going on inside of
Main Home
Analysis Blog
Run A High Pressure Economy? Janet Yellen Does Not Understand the Problem
A Short Note on a Connection Between Marginalist Economics and Folk Medicine
News Blog
Why Amazon Gives So Many Perks To Prime Members
Where Workplace Trust Is Strongest
How A Lack Of Sleep Affects Your Brain - And Personality
How Accurate Are Final US Election Polls
What We Read Today 27 October 2016
A Pony And His Beloved Teddy Bear Reunite After Being Apart For 3 Years
October 2016 Kansas City Fed Manufacturing Remains In Expansion
September 2016 Median Household Income Not Statistically Different Than The Previous Month
September 2016 Pending Home Sales Index Improves
22 October 2016 Initial Unemployment Claims: Rolling Averages Marginally Worsen
Durable Goods New Orders Marginally Declined in September 2016
Infographic Of The Day: 41 Interesting Facts About Tesla Motors
Early Headlines: Asia Stocks Down, Oil Lower, Great Lakes Wind Power, Chinese Moving Mfg To US, Tesla Reports Profit, Dems Forecast To Take Senate, China's Debt And More
Investing Blog
Gold That Pays Dividends
Galaxy Note Disaster Wipes Out Samsung's Mobile Profits
Opinion Blog
Global Debt Investors: The Silence Of The Lambs
A Hard Brexit And Reduced Migration Won't Benefit UK Workers
Precious Metals Blog
Inflation Surging As Platinum Signals Stock Market Decline
Live Markets
27Oct2016 Market Close: Wall Street Closes Fractionally Lower, Interest-Rate Stocks Outweighed Gains In Healthcare, Market Indicators Bearish
Amazon Books & More

.... and keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Middle East / Africa
USA Government

Crowdfunding ....



Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day


Asia / Pacific
Middle East / Africa
USA Government

RSS Feeds / Social Media

Combined Econintersect Feed

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution



  Top Economics Site Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2016 Econintersect LLC - all rights reserved