Fiscal Consolidation in a Currency Union: Spending Cuts vs. Tax Hikes

Jesper Lindé and Christopher Erceg

No 9155, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper uses a two country DSGE model to examine the effects of tax-based versus expenditure-based fiscal consolidation in a currency union. We find three key results. First, given limited scope for monetary accommodation, tax-based consolidation tends to have smaller adverse effects on output than expenditure-based consolidation in the near-term, though is more costly in the longer-run. Second, a large expenditure-based consolidation may be counterproductive in the near-term if the zero lower bound is binding, reflecting that output losses rise at the margin. Third, a "mixed strategy" that combines a sharp but temporary rise in taxes with gradual spending cuts may be desirable in minimizing the output costs of fiscal consolidation.

Keywords: Dsge model; Fiscal policy; Liquidity trap; Monetary policy; Open economy macroeconomics; Zero bound constraint (search for similar items in EconPapers)
JEL-codes: E32 F41 (search for similar items in EconPapers)
Date: 2012-09
New Economics Papers: this item is included in nep-dge, nep-mac, nep-opm and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Related works:
Journal Article: Fiscal consolidation in a currency union: Spending cuts vs. tax hikes (2013)
Working Paper: Fiscal consolidation in a currency union: spending cuts vs. tax hikes (2012)
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