V. Saving behaviour and the effectiveness of fiscal policy

OECD Economic Outlook, Dec, 2004

... but are not necessarily causally-related

The above developments have also coincided with a number of secular influences which could have served to disguise any causal relationship between private and public saving or throw up a spuriously inverse one. Capital market liberalisation would have been an exogenous factor pushing down private saving, while lower inflation has reduced government dissaving. If budget deficits are adjusted for the effect of inflation on debt and debt service payments (i.e. if the inflation tax, measuring the erosion caused by inflation of the real value of government debt, is included as a government receipt), the improvement in budget balances in recent decades is, in some cases, significantly reduced (Figure V.4).

[FIGURE V.4 OMITTED]

Episodes of sharp swings in fiscal stance

Fiscal corrections can be expansionary and vice versa.

A number of case studies can be used to illustrate how compensating shifts in private saving can make fiscal contractions expansionary or fiscal expansions contractionary. In particular, when fiscal policy becomes unsustainable, leading to accelerating inflation and rising interest rates, a fiscal correction, based on either higher taxes or lower government spending, can have a positive, stabilising effect. (2) This type of movement appears not to occur in a linear fashion but to be associated with "trigger points", linked to large and unsustainable fiscal imbalances. (3)

... as evidenced by a number of extreme episodes ...

Two cases of expansionary fiscal consolidation relate to Denmark and Ireland in the 1980s. The Danish fiscal stabilisation of 1983-86 was achieved by retrenching real government consumption, cutting back public investment and raising taxes. The reduction in the deficit was accompanied by a boom in private consumption and investment. In Ireland, the post-1987 stabilisation programme accomplished by slashing government consumption and investment--was the trigger for higher growth. Conversely, the massive increase in the budget deficit in Sweden in the early 1990s was offset by rising private saving, in part due to the negative wealth effects associated with the concomitant fall in housing prices. A common characteristic of these episodes is the presence of strong exogenous wealth effects, but it is likely that direct fiscally-induced effects, related to perceptions about fiscal sustainability, were also present.

... but also when policies are not perceived as unsustainable

There is also evidence of strongly offsetting movements in private and public saving in less extreme cases, when fiscal policies are not deemed unsustainable, although again separating pure fiscal responses from other wealth factors is very difficult. The United States experience during the 1990s provides an example of a fiscal consolidation--based on public spending restraint and revenue windfalls on realised capital gains--associated with a significant decline in private saving. However, while fiscal consolidation provided some of the room for productive investment associated with the asset-price boom, other ("new economy") factors were probably more important. Similarly, the fiscal expansion in Japan over the same period, which was predominantly expenditure-based, saw the private saving ratio rise substantially. But again, the substantial negative wealth effects which occurred were more closely related to exogenous factors, in the form of the decline in equity and land prices, than to fiscal easing.