Macroeconomics

Fiscal Policy in the Long-Run

Faculty of Economics and Business
Universitas Gadjah Mada
Hibert

2022
LEARNING OBJECTIVES

▪ STUDENTS CAN EXPLAIN WHEN FISCAL POLICY IS SUSTAINABLE

AND WHEN IT IS NOT SUSTAINABLE

▪ STUDENTS UNDERSTAND HOW FISCAL POLICY AFFECTS THE

ECONOMY IN THE LONG RUN

▪ STUDENTS CAN DERIVE THE CONDITIONS FOR A SUSTAINABLE

FISCAL POLICY
Fiscal Policy in the Long-Run

Government Budget and Debt

The Impact of Budget Deficit

Fiscal/Debt Sustainability
RATIONALE

▪ In the previous meeting on fiscal policy in the short run, we

discussed how the government uses fiscal policy such as
changes in taxes and government purchases to achieve
macroeconomic goals.
▪ In this meeting, we explain how fiscal policy affects real
variables in the long run.
GOVERNMENT BUDGET AND ITS STATES

▪ Fiscal policy is obviously related with government budget.

▪ Different states of budget:
1. Deficit: The situation in which the government’s spending is greater
than its revenue.
2. Surplus: The situation in which the government’s spending is less
than its revenue.
3. Balanced: The situation in which the government’s spending is
equal with its revenue.
GOVERNMENT BUDGET

Different type of budget deficit:

1. Budget Deficit Budget Deficit
The difference between government 𝐺𝑡 + 𝑇𝑅𝑡 + 𝑖𝑡 𝐵𝑡−1 > 𝑇𝑡
expenditure (𝐺) and tax revenue (𝑇). tingkat suku
bunga

2. Primary Budget Deficit: Primary Budget Deficit:

The difference between government purchases 𝐺𝑡 + 𝑇𝑅𝑡 > 𝑇𝑡
of goods and services (𝐺) plus transfer
payments (𝑇𝑅) minus tax revenue (𝑇). Primer tidak mengaitkan
pembayaran utang bunga
BUDGET DEFICIT

▪ The budget deficit

measures how much the
government borrows in
a year.
▪ Economists often
measure budget deficits
as a fraction of GDP.

PDB menjadi indikator untuk menghitung kemampuan membayar utang

The US Budget Surplus and Deficit, 1901–2010
During wars, government spending increases far more than tax revenues,
increasing the budget deficit. The budget deficit also increases during
recessions, as government spending increases and tax revenues fall.
BUDGET AND PRIMARY BUDGET DEFICIT

The Total Budget Deficit and Primary

Budget Deficit for the United States,
▪ Because interest payments 1962–2010

are always positive, the

primary budget deficit is
always less than the total
budget deficit.
▪ The primary budget deficit
was negative, and therefore
in surplus, most recently
during 2007.

interest payment selalu positi (lebih dari 0) sehingga primary budget deficit
lebih rendah
BUDGET DEFICIT AND INFLATION

We want to show the relationship between government budget

deficit (𝐷𝑒𝑓) and inflation (𝜋). dikaitkan dengan inflasi karena, dijangka panjang harga adalah fleksibel

primary anggaran primer

𝐷𝑒𝑓𝑡 = 𝐺𝑡 + 𝑇𝑅𝑡 + 𝑖𝑡 𝐵𝑡−1 − 𝑇𝑡 GT = pengeluaran umum

TR =

𝐷𝑒𝑓𝑡 = 𝑖𝑡 𝐵𝑡−1 + 𝐺𝑡 + 𝑇𝑅𝑡 − 𝑇𝑡 itbt-1 = pengeluaran dimasa lalu

(bunga utang)
Tt = tax

𝐷𝑒𝑓𝑡 = 𝑖𝑡 𝐵𝑡−1 + 𝑃𝐷𝑡

Recall the concept of nominal interest rates based on Fischer equation
and we have:
𝐷𝑒𝑓𝑡 = 1 + 𝑟𝑡 1 + 𝜋𝑡𝑒 − 1 𝐵𝑡−1 + 𝑃𝐷𝑡
BUDGET DEFICIT AND INFLATION

Now, we want to measure the deficit in terms of nominal output (𝑃𝑌),

so we have deficit to GDP ratio:
𝐷𝑒𝑓𝑡 𝐵𝑡−1 𝑃𝐷𝑡
= 1 + 𝑟𝑡 1 + 𝜋𝑡𝑒 −1 +
𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡
𝐷𝑒𝑓𝑡 𝑃𝑡−1 𝑌𝑡−1 𝐵𝑡−1 𝑃𝐷𝑡
= 1 + 𝑟𝑡 1 + 𝜋𝑡𝑒 −1 +
𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡 𝑃𝑡−1 𝑌𝑡−1 𝑃𝑡 𝑌𝑡
𝑃𝑡 𝑌𝑡
Recall that = 1 + 𝜋𝑡 1 + 𝑔𝑦,𝑡 , so we have
𝑃𝑡−1 𝑌𝑡−1

𝐷𝑒𝑓𝑡 1 + 𝑟𝑡 1 + 𝜋𝑡𝑒 − 1 𝐵𝑡−1 𝑃𝐷𝑡 di expand

= +
𝑃𝑡 𝑌𝑡 1 + 𝜋𝑡 1 + 𝑔𝑦,𝑡 𝑃𝑡−1 𝑌𝑡−1 𝑃𝑡 𝑌𝑡
BUDGET DEFICIT AND INFLATION

Now, we can simplify the equation to:

𝐷𝑒𝑓𝑡 1 + 𝑟𝑡 1 + 𝜋𝑡𝑒 − 1 𝐵𝑡−1 𝑃𝐷𝑡

= +
𝑃𝑡 𝑌𝑡 1 + 𝜋𝑡 1 + 𝑔𝑦,𝑡 𝑃𝑡−1 𝑌𝑡−1 𝑃𝑡 𝑌𝑡

𝐷𝑒𝑓𝑡 𝑟𝑡 + 𝜋𝑡𝑒 𝐵𝑡−1 𝑃𝐷𝑡

≈ +
𝑃𝑡 𝑌𝑡 1 + 𝜋𝑡 + 𝑔𝑦,𝑡 𝑃𝑡−1 𝑌𝑡−1 𝑃𝑡 𝑌𝑡
BUDGET DEFICIT AND INFLATION: EXAMPLE

For simplicity, we assume:

𝐵𝑡−1 𝐵𝑡−2
(i) the debt ratio has been constant = =1 untuk simplimikasi dengan utang
- PDB nominal adalah sama
𝑃𝑡−1 𝑌𝑡−1 𝑃𝑡−2 𝑌𝑡−2 - Anggaran primer = 0
𝑃𝐷𝑡
(ii) there is primary balance =0
𝑃𝑡 𝑌𝑡

So, we have

𝐷𝑒𝑓𝑡 𝑟𝑡 + 𝜋𝑡𝑒 𝐵𝑡−1 𝑃𝐷𝑡

≈ +
𝑃𝑡 𝑌𝑡 1 + 𝜋𝑡 + 𝑔𝑦,𝑡 𝑡−1 𝑡−1 𝑃𝑡 𝑌𝑡
𝑃 𝑌
𝐷𝑒𝑓𝑡 𝑟𝑡 + 𝜋𝑡𝑒
≈
𝑃𝑡 𝑌𝑡 1 + 𝜋𝑡 + 𝑔𝑦,𝑡
bahwa rasio antara difisit anggaran dengan PDB mendekati rasio nominal
interest rate itu sendiri
BUDGET DEFICIT AND INFLATION: EXAMPLE

Current Period Future Period

tingkat pertumbuhan yang real

If we set both the real growth rate and the If inflation jumps from zero in period 𝑡 to 10% in
real interest rate at a steady 2 percent and period 𝑡 + 1 without any change in real variables,
inflation is fully and correctly anticipated in then the deficit to GDP ratio will be
interest rates (i.e.,𝜋 = 𝜋 𝑒 ), so we have 𝐷𝑒𝑓𝑡 0.02 + 𝜋𝑡
masyarakat benar-benar dapat memprediksi inflasi ≈
𝐷𝑒𝑓𝑡 𝑟𝑡 + 𝜋𝑡 𝑃𝑡 𝑌𝑡 1 + 𝜋𝑡 + 0.02
≈
𝑃𝑡 𝑌𝑡 1 + 𝜋𝑡 + 𝑔𝑦,𝑡 𝐷𝑒𝑓𝑡 0.02 + 0.1
≈
𝑃𝑡 𝑌𝑡 1 + 0.1 + 0.02
𝐷𝑒𝑓𝑡 0.02 + 𝜋𝑡
≈ 𝐷𝑒𝑓𝑡 0.12
𝑃𝑡 𝑌𝑡 1 + 𝜋𝑡 + 0.02
≈ ≈ 11%
𝑃𝑡 𝑌𝑡 1.12
If we assume inflation rate equal zero percent at
time t 𝜋𝑡 = 0 , the deficit to GDP ratio will be
𝐷𝑒𝑓𝑡 0.02 In this polar case, inflation raises the deficit ratio
≈ ≈ 2%
𝑃𝑡 𝑌𝑡 1.02 substantially.
ketika inflasi naik malah akan membebani negara di jangka panjang
GOVERNMENT BUDGET: INDONESIA

Indonesia: Summary
of Central Government
Operations, 2015–21
(In percent of GDP)

total defisit pemerintah / APBN Total Budget Deficit

GOVERNMENT BUDGET: INDONESIA

Indonesia: Summary of Central Government Operations, 2015–21

Primary Budget Deficit (Balance) ketika negatif maka primary defisit

0 primary balance
GOVERNMENT BUDGET: INDONESIA

Indonesia: Summary of Central Government Operations, 2015–21

PRIMARY BALANCE/DEFICIT

The analysis of the structural fiscal balance typically focuses on the cyclically adjusted primary
balance.
Indonesia Primary and Cyclically Adjusted Balance
PRIMARY (In Percent of GDP)
BALANCE

STRUCTURAL
BALANCE

CYCLICAL
EFFECT
BT = 1. Trend
2. Siklis
3 Reminder

untuk mengadjust data, untuk mendapatkan koefisien yang stabil

digunakan untuk tabel nominal yang ada unsur harganya
PRIMARY BALANCE/DEFICIT

The analysis of the structural fiscal balance typically focuses on the cyclically adjusted primary
balance.

PRIMARY 𝑃𝑟𝑖𝑚𝑎𝑟𝑦 𝐵𝑎𝑙𝑎𝑛𝑐𝑒 = 𝑆𝑡𝑟𝑢𝑐𝑡𝑢𝑟𝑎𝑙 𝐶𝑜𝑚𝑝𝑜𝑛𝑒𝑛𝑡 + 𝐶𝑦𝑐𝑙𝑖𝑐𝑎𝑙 𝐶𝑜𝑚𝑝𝑜𝑛𝑒𝑛𝑡

BALANCE

STRUCTURAL
𝑇𝑅 ∗ − 𝑃. 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 ∗
BALANCE

CYCLICAL
(𝑇𝑅 − 𝑇𝑅 ∗ ) − (𝑃. 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 − 𝑃. 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 ∗ )
EFFECT
komplemen data nya dikurangan cyclical complement

Where 𝑃. 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 is noninterest spending.

* denotes the structural (or cyclically-adjusted) value of a variable
GOVERNMENT DEBT

▪ When the government runs a budget deficit, it does not have

sufficient tax revenue to pay for all its expenditures.
▪ To finance the deficit, government issues new bonds that are
bought by investors.
▪ The government debt (total value of government bonds
outstanding) is a stock variable, while the budget deficit is a
flow variable.

kt-1
Kt = ( 1 - d )
GOVERNMENT DEBT

Gross Federal Debt and Gross Federal Debt Held by the

▪ Gross federal debt is the total dollar
Public for the United States, 1939–2010
value of Treasury bonds and other
federal agency bonds plus the dollar
value of the small amount of bonds
and other securities issued by other
federal agencies. utang yang dipegang masyarakat luar negeri

▪ Gross federal debt is greater than

debt held by the public, but the two
measures of federal debt track each
other closely over time.

▪ Debt is calculated as the ratio of

fiscal year debt to calendar year
GDP.
DEBT TO GDP

Government Debt/GDP, Selected

Countries, Weighted Average

We can think of the budget deficit as the yearly flow

of new government bonds, ∆𝐵
nilai obligasi
▪ The value of bonds increases, when the
government runs a budget deficit.
𝐺 > 𝑇 −−→ ∆𝐵 > 0
▪ The value of bonds decreases, when the
government runs a budget surplus:
𝐺 < 𝑇 −−→ ∆𝐵 < 0 Source: IMF/WEO
▪ In most cases, government borrowed funds to overcome budget
deficit problem (e.g. issuing bonds).

▪ Most developed nations suffers from a long-term fiscal problem:

Their national debt is expected to increase rapidly in the future.
INDONESIA EXTERNAL DEBT

Indonesia: Composition of External Debt Indonesia External Debt, 2019

(In percent of GDP) (In percent of GDP)
Fiscal Policy in the Long-Run

Government Budget and Debt

The Impact of Budget Deficit

Fiscal/Debt Sustainability
SHORT-RUN EFFECTS OF BUDGET DEFICITS

The conventional view among economists is that a budget deficit

crowds out investment:
▪ If the government runs a budget deficit that is not financed through
seigniorage, then the government must issue additional government bonds.
▪ If the government borrows $100 billion, then that is $100 billion that
households and firms cannot borrow to finance investment.
▪ As a result, the supply curve for loanable funds decreases, causing the real
interest rate to increase and the equilibrium amount of investment to
decrease.
crowd out investment = nilai investasi kalah saing dari
pemerintah
SHORT-RUN EFFECTS OF BUDGET DEFICITS

The Effect of Government

Budget Deficits on Real Interest
Rates and Investment
▪ A government budget deficit
reduces the supply of loanable
funds, so the supply curve
shifts to the left.
▪ As a result, the real interest
rate increases and the
equilibrium amount of
investment decreases.
loanable funds = uang yang bisa dipinjamkan

investasi pemerintah akan mengurangi investasi privat

LONG-RUN EFFECTS OF BUDGET DEFICITS

The Long-Run Effect of an Increase in

the Budget Deficit
untuk menambah output maka harus menambah kapitalnya ▪ A higher budget deficit reduces
national saving, so the saving rate
decreases.

n = pertumbuhan populasi
▪ As a result, the investment curve
shifts downward, and the economy’s
steady-state equilibrium moves from
point A to point B.
▪ The result is a lower capital-to-labor
akan menyebabkan crowding out ratio and lower productivity.
▪ The lower productivity leads to a
lower level of potential GDP along the
balanced growth path.
secara tidak terkontrol akan menyebabkan penurunan PDB
LONG-RUN EFFECTS OF BUDGET DEFICITS

The Conventional View of Fiscal Policy and Potential GDP in the Long Run
Fiscal Policy in the Long-Run

Government Budget and Debt

The Impact of Budget Deficit

Fiscal/Debt Sustainability
THE GOVERNMENT BUDGET CONSTRAINT

There are several important issues concerning the effects of the government debt on the economy. Before
we can analyze the key issues connected with the debt, we need to understand the government’s budget
constraint.

Governments face a budget constraint (because total spending cannot

exceeds total revenue) when they make a decision to affect the economy:
𝐺𝑡 + 𝑇𝑅𝑡 + 𝑖𝑡 𝐵𝑡−1 = 𝑇𝑡 + ∆𝐵𝑡 + ∆𝑀𝐵𝑡

𝑊ℎ𝑒𝑟𝑒:
𝐺𝑡 is government spending
𝑇𝑅𝑡 is transfer payments
𝑖𝑡 𝐵𝑡−1 is interest payment on existing debt
𝑇𝑡 is tax revenue
𝐵𝑡 is new government bonds
𝑀𝐵𝑡 is monetary base (seigniorage)
THE GOVERNMENT BUDGET CONSTRAINT

There are several important issues concerning the effects of the government debt on the economy. Before
we can analyze the key issues connected with the debt, we need to understand the government’s budget
constraint.

Governments face a budget constraint (because total spending cannot

exceeds total revenue) when they make a decision to affect the economy:
𝐺𝑡 + 𝑇𝑅𝑡 + 𝑖𝑡 𝐵𝑡−1 = 𝑇𝑡 + ∆𝐵𝑡 + ∆𝑀𝐵𝑡
Total Spending Revenue
THE GOVERNMENT BUDGET CONSTRAINT

There are several important issues concerning the effects of the government debt on the economy. Before
we can analyze the key issues connected with the debt, we need to understand the government’s budget
constraint.

Governments face a budget constraint (because total spending cannot

exceeds total revenue) when they make a decision to affect the economy:
𝐺𝑡 + 𝑇𝑅𝑡 + 𝑖𝑡 𝐵𝑡−1 = 𝑇𝑡 + ∆𝐵𝑡 + ∆𝑀𝐵𝑡
(𝐺𝑡 + 𝑇𝑅𝑡 − 𝑇𝑡 ) + 𝑖𝑡 𝐵𝑡−1 = ∆𝐵𝑡 + ∆𝑀𝐵𝑡
𝑃𝐷𝑡 + 𝑖𝑡 𝐵𝑡−1 = ∆𝐵𝑡 + ∆𝑀𝐵𝑡

Where PD = Primary Budget Deficit

THE SUSTAINABILITY OF FISCAL POLICY

▪ Using the governments budget constraint, we want to examine whether

the government’s fiscal policy is sustainable.
▪ We express the budget constraint relative to nominal GDP (the value of
final goods and services produced in the economy):
𝑃𝐷𝑡 + 𝑖𝑡 𝐵𝑡−1 = ∆𝐵𝑡 + ∆𝑀𝐵𝑡

𝑃𝐷𝑡 𝐵𝑡−1 ∆𝐵𝑡 ∆𝑀𝐵𝑡

+ 𝑖𝑡 = +
𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡
THE SUSTAINABILITY OF FISCAL POLICY

Therefore, we derive the conditions for a sustainability of fiscal policy:

𝑃𝐷𝑡 𝐵𝑡−1 ∆𝐵𝑡 ∆𝑀𝐵𝑡

+ 𝑖𝑡 = +
𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡

𝐵𝑡 𝑃𝐷𝑡 𝐵𝑡−1 ∆𝑀𝐵𝑡

∆ = + 𝑟𝑡 − 𝑔𝑦,𝑡 −
𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡 𝑃𝑡−1 𝑌𝑡−1 𝑃𝑡 𝑌𝑡
WHEN IS FISCAL POLICY SUSTAINABLE?

The debt is sustainable when the debt-to-GDP ratio is either constant or

declining. To simplify our discussion, we set some assumptions:

𝐵𝑡 𝑃𝐷𝑡 𝐵𝑡−1 ∆𝑀𝐵𝑡

∆ = + 𝑟𝑡 − 𝑔𝑦,𝑡 −
𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡 𝑃𝑡−1 𝑌𝑡−1 𝑃𝑡 𝑌𝑡

𝐵𝑡 𝐵𝑡−1 Assumption 1:
∆ = 𝑟𝑡 − 𝑔𝑦,𝑡 ∆𝑀𝐵𝑡 =0
𝑃𝑡 𝑌𝑡 𝑃𝑡−1 𝑌𝑡−1
Assumption 2:
𝑃𝐷𝑡 =0
WHEN IS FISCAL POLICY SUSTAINABLE?

Under these conditions, the change in debt-to-GDP ratio depends only on

the real interest rate 𝑟𝑡 and the growth rate of real GDP 𝑔𝑦 :
𝐵𝑡 𝐵𝑡−1
∆ = 𝑟𝑡 − 𝑔𝑦,𝑡
𝑃𝑡 𝑌𝑡 𝑃𝑡−1 𝑌𝑡−1
WHEN IS FISCAL POLICY SUSTAINABLE?

Under these conditions, the change in debt-to-GDP ratio depends only on the real
interest rate 𝑟𝑡 and the growth rate of real GDP 𝑔𝑦 :

𝐵𝑡 𝐵𝑡−1
∆ = 𝑟𝑡 − 𝑔𝑦,𝑡
𝑃𝑡 𝑌𝑡 𝑃𝑡−1 𝑌𝑡−1
▪ If:
𝑟𝑡 > 𝑔𝑦,𝑡
▪ Then: ▪ The debt-to-GDP ratio will increase even if the
government has a primary deficit of zero.
𝐵𝑡 ▪ In this case, the government is forced to run a
∆ >0 primary surplus just to prevent the debt-to-GDP
𝑃𝑡 𝑌𝑡 ratio from rising to higher levels.
jika interest rate berhubungan dengan debt
WHEN IS FISCAL POLICY SUSTAINABLE?

Under these conditions, the change in debt-to-GDP ratio depends only on the real
interest rate 𝑟𝑡 and the growth rate of real GDP 𝑔𝑦 :

𝐵𝑡 𝐵𝑡−1
∆ = 𝑟𝑡 − 𝑔𝑦,𝑡
𝑃𝑡 𝑌𝑡 𝑃𝑡−1 𝑌𝑡−1
▪ If:
𝑟𝑡 < 𝑔𝑦,𝑡
▪ Then: ▪ The debt-to-GDP ratio will decrease.

▪ In this case, it is still possible to have a primary

𝐵𝑡 deficit greater than zero and still have a
∆ <0 sustainable fiscal policy.
𝑃𝑡 𝑌𝑡
WHEN IS FISCAL POLICY SUSTAINABLE?

▪ A fiscal policy is sustainable if it leads to a constant or

decreasing debt-to-GDP ratio.
▪ The debt-to-GDP ratio is affected by, holding everything else
constant, (1) primary deficit, (2) nominal interest rate, (3) GDP
growth, and (4) seigniorage.
biasanya sangat kecil
THE IMPACT OF INFLATION & EXCHANGE RATE
CHANGES ON FISCAL SUSTAINABILITY

If we want to analysis the dynamic

of fiscal sustainability and to
examine the impact of exchange
rate and inflation, we must BOND
decompose type of debt.

DOMESTIC FOREIGN
Suppose, bond can be divided into BOND BOND
foreign currency bond and home
currency bond.
𝐵 = 𝐵𝐷 + 𝐵𝐹
THE IMPACT OF INFLATION & EXCHANGE RATE
CHANGES ON FISCAL SUSTAINABILITY

If we want to analysis the dynamic EXAMPLE OF DIFFERENT TYPE OF BOND

of fiscal sustainability and to
FIXED RATE DOMESTIC BOND (IDR)
examine the impact of exchange fixed rate

rate and inflation, we must

decompose type of debt.

Suppose, bond can be divided into

foreign currency bond and home
currency bond. FIXED RATE GLOBAL BOND (USD)
𝐵 = 𝐵𝐷 + 𝐵𝐹
THE IMPACT OF INFLATION & EXCHANGE RATE
CHANGES ON FISCAL SUSTAINABILITY

If we want to analysis the dynamic EXAMPLE OF DIFFERENT TYPE OF BOND

of fiscal sustainability and to
SHARIA: PROJECT BASED SUKUK - IDR
examine the impact of exchange
rate and inflation, we must
decompose type of debt.

Suppose, bond can be divided into

SHARIA: PROJECT BASED SUKUK - USD
foreign currency bond (𝐵𝐹 ) and
home currency bond (𝐵𝐷 ).
𝐵 = 𝐵𝐷 + 𝐵𝐹
THE IMPACT OF INFLATION & EXCHANGE RATE
CHANGES ON FISCAL SUSTAINABILITY

Recall our previous equation of fiscal sustainability

𝐵𝑡 𝑃𝐷𝑡 1 + 𝑖𝑡 𝐵𝑡−1 ∆𝑀𝐵𝑡

= + −
𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡 1 + 𝜋𝑡 + 𝑔𝑦,𝑡 𝑃𝑡−1 𝑌𝑡−1 𝑃𝑡 𝑌𝑡

We divide bond into foreign currency bond and home currency bond :
𝐷 𝐹
𝐵𝑡 𝑃𝐷𝑡 1 + 𝑖𝑡 𝐵𝑡−1 𝐵𝑡−1 ∆𝑀𝐵𝑡
= + + −
𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡 1 + 𝜋𝑡 + 𝑔𝑌𝑡 𝑃𝑡−1 𝑌𝑡−1 𝑃𝑡−1 𝑌𝑡−1 𝑃𝑡 𝑌𝑡
THE IMPACT OF INFLATION & EXCHANGE RATE
CHANGES ON FISCAL SUSTAINABILITY

Converting upper case letters to lower case letters to denote ratios to GDP,
and rearranging terms, yields
𝐷 𝐹
𝐵𝑡 𝑃𝐷𝑡 1 + 𝑖𝑡 𝐵𝑡−1 𝐵𝑡−1 ∆𝑀𝐵𝑡
= + + −
𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡 1 + 𝜋𝑡 + 𝑔𝑌𝑡 𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡 𝑃𝑡 𝑌𝑡
1 + 𝑖𝑡 𝐷 𝐹
𝑏𝑡 = 𝑝𝑑𝑡 + 𝑏𝑡−1 + 𝑏𝑡−1 − ∆𝑚𝑏𝑡
1 + 𝜋𝑡 + 𝑔𝑌𝑡
THE IMPACT OF INFLATION & EXCHANGE RATE
CHANGES ON FISCAL SUSTAINABILITY

We want the debt dynamics – i.e., the change in the debt ratio (∆𝑏𝑡 ):
1 + 𝑖𝑡 𝐷 𝐹
𝑏𝑡 = 𝑝𝑑𝑡 + 𝑏𝑡−1 + 𝑏𝑡−1 − ∆𝑚𝑏𝑡
1 + 𝜋𝑡 + 𝑔𝑦𝑡
𝐷 𝐹
1 𝑏𝑡−1 𝑏𝑡−1 𝑓 𝑓
∆𝑏𝑡 = 𝑝𝑑𝑡 + 𝑖𝑡𝐷 𝐹
+ 𝑖𝑡 𝑏𝑡 − 𝑔𝑦𝑡 𝑏𝑡−1 − 𝜋𝑡 1 + 𝑔𝑦𝑡 𝑏𝑡−1 + 𝜀𝑡 (1 + 𝑖𝑡 )𝑏𝑡−1 − ∆𝑚𝑏𝑡
1 + 𝜋𝑡 + 𝑔𝑦𝑡 𝑏𝑡−1 𝑏𝑡−1

We can separate the change in the debt ratio into five components:
▪ An interest rate effect: Higher interest rates increase the debt ratio
▪ A nominal growth effect: Higher nominal growth reduce the debt ratio
▪ An exchange rate effect: A depreciation increases the debt ratio when some debt is in foreign currency
jika bond banyak dari pada foreign currency maka akan menyebabkan
THE IMPACT OF INFLATION & EXCHANGE RATE
CHANGES ON FISCAL SUSTAINABILITY

Consider an important practical case: the effect of inflation where all (or
even most) debt is in domestic currency.
▪ Debt dynamics and thus sustainability are unaffected by inflation only if
the effective real interest rate on government debt is impervious to
inflation.
▪ In the real world, however, insofar as part of government debt is long
term and at fixed nominal interest rates, higher inflation can reduce the
effective real interest rate on government debt and thus the government
debt ratio.
investasi di indonesia dipengaruhi oleh komuditas real (harga2 komuditas)
ketika pemerintah utang dan berkesinambungan maka inflasi tidak
berpengaruh banyak pada real interest rate
TPID = Tim Pengendali inflasi
THANK YOU