Discussion of Policy Volatility, Institutions and Economic Growth By Antonio Fatás and Ilian Mihov By Vicente Tuesta Central Bank of Perú March, 2006

Motivation  Institutions versus Discretionary Macroeconomic Policies  Standard view: good macroeconomic policies are the cause of increased stability.  AJRT (2003) Bad macroeconomic policies are just the symptoms of weak institutions (key instrument to shape current institutions…..mortality rate).

What do the authors do?  Re-evaluate whether macroeconomic policies matter for economic performance.  Evaluate causal effect from institutions to fiscal policy volatility

How?  They construct a measure that captures the exogenous component of fiscal stance.

What do they find?  Fiscal policy volatility affects growth negatively (a significant direct effect) Institutions are important to the extent that they shape policy outcomes (40%)

Comment I: Exogeneity of fiscal Stance  Sample of coutries: Developing economies have less room to be countercyclical, therefore larger volatility during crises. Larger volatility in developing countries, institutions might be less informative....  Institution is a highly persistent state variable.  Growth is very disperse across countries as it is volatility.  Therefore: volatility of might be a good candidate to have an effect on growth.  What about the level of the shocks? Large errors are the driving forces!!  Reduced form estimation. Some general equilibrium story is needed.

Comment II: What else can explain fiscal policy volatility?  Institutions are just a part of it (for the whole sample of countries)  A country’s capacity to absorve other shocks (i.e. terms of trade shocks, foreign interest rate shocks)

Comment III: Non lineal effects  If discretionary fiscal policy is important, how much discretion is optimal? Which level of fiscal policy volatility is good?  Developed and developing countries must have different threholds of fiscal volatility.

Comment IV: Channels of transmission  Policy volatility: Investment  But, this is not the case for rich countries.  Puzzle, given the link between policy volatility and growth.  Risk-Sharing is easier in rich countries than in developing countries.  Financial integration might help developing countries.

Comment V: Another channel  Fiscal volatility is associated to demand shocks.  What about supply shocks?  Kydland and Prescott (1982): TFP explains great part of macro volatility  Technological adoption might be significantly linked to institutional variables (i.e. barriers such as legal constraints). I guess its omission is not neutral to the analysis.

Growth in Perú Negative relationship Macro Stability is needed

Fiscal Policy Primari deficit: less pro-cyclical and less volatile during

Monetary Policy Ahora: Countercylical Policy: Y   interest rates  Before IT: Procyclical monetary policy

Conclusion  A great contribution. It generates debate in the literature of economic growth  Very careful estimations. But a deeply theoretical understanding of the link between fiscal policy volatility and growth is needed.