Fiscal consolidation in a currency union: Spending cuts vs. tax hikes

Christopher Erceg and Jesper Lindé

Journal of Economic Dynamics and Control, 2013, vol. 37, issue 2, 422-445

Abstract: This paper uses a two country DSGE model to examine the effects of tax-based vs. 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: Monetary policy; Fiscal policy; Liquidity trap; Zero bound constraint; Open economy macroeconomics; DSGE model (search for similar items in EconPapers)
JEL-codes: E32 F41 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (139)

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Related works:
Working Paper: Fiscal Consolidation in a Currency Union: Spending Cuts vs. Tax Hikes (2012)
Working Paper: Fiscal consolidation in a currency union: spending cuts vs. tax hikes (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:37:y:2013:i:2:p:422-445

DOI: 10.1016/j.jedc.2012.09.012

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