Fiscal and Monetary Policy

Fiscal and Monetary Policy

To realize the ambitious goals of his economic program, Barco initiated coordinated fiscal and monetary policies that he hoped would influence major macroeconomic variables, including GDP, interest rates, and price levels. His primary goals included reducing real interest rates to encourage business investment and economic expansion, stabilizing the inflation rate at 20 to 25 percent, and redirecting public resources to help the poor.

The administration embarked upon a restrictive fiscal scheme designed to reduce deficit spending. Whereas the previous administration's annual deficits averaged nearly 5 percent of GDP, the Barco plan called for reducing deficit spending to less than 3 percent of GDP. To meet his spending goals, Barco counted on solid growth of GDP as well as a new budget approach that would redirect funds away from infrastructure to social programs. The tax burden was also shifted slightly from businesses to individuals. Planners had anticipated that the combined effects would allow the administration to meet spending levels within deficit guidelines, but by early 1988 it appeared that the deficits would exceed initial estimates.

One of the first steps taken by the Barco administration to implement the deficit reduction policy was to alter the tax structure. Principal changes included reducing the corporate tax rate to 30 percent of revenues, eliminating double taxation, phasing out tax deductions related to inflation adjustments, and increasing personal income taxes. The government assumed that an energized business sector would bring growth to other areas of the economy.

The Barco administration outlined a strict budget to curtail deficits. Preliminary estimates of the 1988 budget indicated that income tax and indirect taxes, such as customs, gasoline, and sales duties, would be the primary revenue sources. Additional income, constituting 20 to 30 percent of total revenue, would be earned from capital receipts, including long-term debt, and various nontax income. Expenditure targets were more difficult to meet; approximately 57 percent of all expenses were absorbed by operational expenditures of the government with 29 percent allocated to foreign and domestic debt service and 14 percent to public investment. This deviated from initial budget projections, which had indicated slightly higher allocations to debt service and public investment. Seventy-five percent of the deficit was to be financed from domestic sources; the remainder was to be financed from foreign borrowing.

Although expenses exceeded budget projections, revenues often failed to meet expectations as well. For example, President Barco inherited a budget of dwindling revenues, reflecting in part the reduction in gross tax receipts consistent with the economic downturn earlier in the 1980s. Colombia's public finances depended on coffee taxes, including a value-added tax on coffee exports, customs duties, and profits from central bank exchange operations, all of which suffered in the mid-1980s. In 1986, however, receipts rebounded sharply because of the coffee boom, which yielded greater import receipts based on additional sales abroad. Publicly managed enterprises that operated at a loss also contributed to budget deficits. Improving management and budgetary control in these organizations was outlined as another specific way to reduce public costs.

Like the budget process, public investment was seen by the Barco administration as an important means by which to re-order priorities. In the early 1980s, for example, at least 55 percent of all public investment funds had gone to physical infrastructure, with the sole exception of 1982, when 43 percent of public investment was so allocated. Money was concentrated in power, transportation, and communications projects, in that order. Social infrastructure, including water, education, and health projects, absorbed 7 to 13 percent of public investment during these years, with 10 to 25 percent going to the productive sector, primarily to expand agriculture and mining. Any remaining funds went unallocated until the next fiscal year.

By contrast, the Barco government planned to change the composition of public investment by increasing the allotment to the social sector while reducing funds previously directed toward physical infrastructure projects. This was consistent with his administration's long-term goal of alleviating poverty so that social discontent and widespread violence might be defused. By early 1988, however, the fiscal deficit exceeded earlier estimates, which forced the government to reduce some of the planned increases in social programs in order to meet other obligations, such as interest payments on the national debt.

The Barco government also adjusted monetary policies to meet program goals. Monetary policy was coordinated under the Monetary Board (Junta Monetaria), which by the 1980s had responsibility for policy development; specific directives were carried out by the Bank of the Republic (Banco de la República). As the central bank, the Bank of the Republic issued currency, sold or purchased securities in the open market, set reserve requirements for the banking system, and acted as the "lender of last resort." In 1986 the government also controlled Colombia's money through numerous public sector saving institutions responsible for funneling credit to specialized projects such as housing and agricultural development.

The government implemented monetary policy by traditional methods, such as adjusting lending rates to banks, controlling monetary growth, setting reserve requirements, and determining exchange rate policy in the belief that, under certain circumstances, inflation and interest rates could be controlled. The Barco government, however, demonstrated a clear preference for allowing the money supply and interest rates to float relatively freely, provided that prices remained within certain broad limits.

Government bodies sometimes have intervened in money markets, however, in an attempt to influence price levels. Fearing that the money supply's relatively quick expansion in 1987 would be too inflationary, the government chose to raise reserve requirements. By early 1988, this tactic was considered inadequate, and the central bank turned to open market operations to reduce the money supply.

Managing exchange rates was another form of monetary control, and it too contributed to economic expansion. The Barco administration continued with the "crawling peg" devaluation system begun in 1967. This policy succeeded in keeping prices of Colombian goods attractively low in the external market. It also drove the prices of imported goods up, improving the trade balance and foreign exchange reserves.

By early 1988, the Barco administration's moderate approach toward economic management appeared to be working. A cautious fiscal policy combined with a free monetary policy seemed to help real interest rates fall from about 10 percent in 1985 to a little over 5 percent in 1987. Private investment grew during this same period from slightly less than 8 percent to over 10 percent of GDP, with aggregate economic growth reaching an average of approximately 5 percent for the two-year period. Inflation remained within the prescribed 20 to 25 percent range.

Colombia, however, was a relatively small economy by world standards, and its interest rates tended to follow those of the major world economies. Because global interest rates also fell during the late 1980s, it was likely that any success attributed to Colombia's macroeconomic policies in meeting stabilization and growth goals was assisted, at least in part, by similar trends in the international economy.

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