MODELING THE NONLINEAR FISCAL REACTION FUNCTION IN MALAYSIA

The fiscal reaction function (FRF) provides valuable insights into a country’s fiscal sustainability and output stability. However, there is no consensus yet on how to model it. Thus, this study investigates the best functional form for the FRF by adopting a nonlinear autoregressive distributed lag approach that accounts for a potential structural break in the data across periods. We examine the case of Malaysia and address the country’s data by using a break-point of the unit root test. The test results indicate the presence of a structural break in the country’s FRF. Moreover, the primary balance of Malaysia has an asymmetrical reaction to the country’s public debt and the output gap. This result suggests that a nonlinear behavior of FRF with a structural break is an accurate approach for the fiscal authority in Malaysia (for example, the Ministry of Finance) in designing prudent fiscal policy. This study finds that an asymmetric fiscal reaction in Malaysia neither guarantees fiscal sustainability nor supports output stability, thus suggesting the need for an independent fiscal council to promote prudent fiscal policy.

Fiscal reaction functions for the advanced economies revisited

We revisit the relationship between the primary balances/GDP and debt/GDP ratios (fiscal reaction function, FRF), in the advanced economies, showing that using adequate tests and estimators leads to question the validity of the current consensus. Using data for 1961–2019, we find that long-run FRFs exist only in a small number of advanced economies (Belgium, Germany, Greece, Norway, Portugal and Sweden), with polynomial effects with fiscal fatigue only in Germany. These results warn against the widespread practice of estimating homogeneous polynomial panel FRFs. Limiting the sample to 1961–2007, thus excluding the 2008 crisis and its aftermath, FRFs hold also in Canada, Ireland, Italy (polynomial), Spain and USA, though not in Germany, and the coefficients are generally larger. Particularly, after 2008 European Union countries appear somehow to have been more likely to implement FRFs.

Asymmetries in the monetary policy reaction function: evidence from India

This paper analyzes the reaction function of monetary authority in India from 1997Q 1 to 2019Q 4 using nonlinear Taylor rule. It has been found that monetary policy reaction function (MPRF) in India is asymmetric and is influenced by the state of the economy, determined by the lagged interest rate. To capture such asymmetry, we have used a set of nonlinear models including smooth transition regression (STR) model, threshold regression (TR) model and Markov-switching regression (MSR) model along with the instrumental variable estimation technique. The analysis discloses that the behaviour of the Reserve Bank of India (RBI) is asymmetric, reacts aggressively to output gap in general and particularly during periods of high interest rate. Furthermore, the RBI reacts more to inflation and output gap during low volatile regimes in MSR models compared to high volatile regimes. We also found that there is a high degree of inertia in the policy rates of the RBI. The study concludes that nonlinear models may not only help in understanding the behaviour of the RBI but also prevent from making incorrect and misleading conclusions in Indian context.

Validity of Taylor's rule for Turkey: An empirical study

The aim of this paper is to propose an estimate of the reaction function of Turkey's monetary policy for the periods from January 2005 to January 2020. In this perspective, a VAR (Vector Autoregressive) model is set up. The VAR model was estimated using Stata software. In this study, the Taylor rule is extended by implicating the industrial production index and the monetary aggregate M2 into policy reaction function. By doing so, the Taylor rule is investigated for the Turkish economy, and the validity of the rule is tested. The results of the ADF test show for all the observed variables that the null hypothesis of a unit root is rejected. In other words, the condition of stationarity seems to be satisfied. In the short term, it seems that a change in the behavior of the variable M2 has an impact of 1% on the level of the current inflation rate as well as the current real interest rate. For the period studied, the results of the VAR modeling indicate that Taylor's rule is partly true for the short term but that it is not for the long term. The choice of the period studied seems to be the main reason for the non-cointegration between the inflation rate and the bank rediscount rate.

Strategic Welfare Policies with Migration: A Theoretical Model and Empirical Evidence

We test the welfare magnet hypothesis for Europe. We modify the existing theoretical frameworks assuming that: (a) welfare services, intended as the output of welfare expenditure, not the poor’s income or social expenditure, enter the median voter’s utility function; (b) preferences depend on the position of the median voter in the income distribution; and (c) the total amount of welfare services provided may differ from the amount needed to finance them, because of inefficiencies in the transfer process. We then test the welfare magnet hypothesis for 22 European countries by estimating a reaction function corresponding to the generic form adopted by the literature, but using the variables inspired by the model. We find evidence of a positive strategic interaction among countries, which suggests a downward bias in the choice of the protection level because of welfare competition. The level of social protection also positively depends on GDP, the redistributive attitudes of residents and their weight in the population, vis-à-vis the migrants’ share, and the efficiency of social expenditure.