Fiscal Consolidations: Can We Reap the Gain and Escape the Pain?

Maria Ferrara and Patrizio Tirelli

No 283, Working Papers from University of Milano-Bicocca, Department of Economics

Abstract: Under limited asset market participation fiscal consolidations have a deep and prolonged deflationary effect, causing substantial short term welfare losses to households whose access to financial markets is limited. We show that it is possible to both reduce public debt and boost consumption of constrained households. This is obtained by allowing taxes to immediately undershoot their post-consolidation steady-state values. A similar result is achieved if temporary public transfers to constrained households are exploited to stimulate demand. We also find that an interest rate rule which reacts not only to inflation but also to the output gap is an effective complement to fiscal policy as a stabilization tool. In fact, the output gap target induces the Central Bank to implement a stronger interest rate cut which triggers a surge in the consumption of Ricardian households. This, in turn, has beneficial effects on labor incomes and on RT households' consumption. We obtain the apparently paradoxical result that such a policy allows to obtain better control of inflation, limiting deflationary pressures.

Keywords: Fiscal Consolidation; DSGE modelling; Rule of Thumb Con- sumers; Fiscal Policy; Monetary Policy; Zero Lower Bound (search for similar items in EconPapers)
JEL-codes: E32 E62 E63 (search for similar items in EconPapers)
Pages: 34
Date: 2014-10, Revised 2014-10
New Economics Papers: this item is included in nep-dge and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

Downloads: (external link)
http://repec.dems.unimib.it/repec/pdf/mibwpaper283.pdf First version, 2014 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:mib:wpaper:283

Access Statistics for this paper

More papers in Working Papers from University of Milano-Bicocca, Department of Economics Contact information at EDIRC.
Bibliographic data for series maintained by Matteo Pelagatti (matteo.pelagatti@unimib.it).