The fiscal arithmetic of a slowdown in trend growth

Mariano Kulish and Nadine Yamout

European Economic Review, 2024, vol. 168, issue C

Abstract: We study the fiscal policy implications of a slowdown in trend growth using an estimated stochastic growth model. Our analysis underscores the risks associated with fiscal rules linked to growth rates, which may prove unsustainable under permanent shifts in productivity growth. For equilibria to exist, fiscal policy must respond to the slowdown ensuring that the government budget constraint holds in the low growth regime. While the slowdown imposes significant welfare costs on households, it also triggers a substantial endogenous response that boosts capital accumulation and functions as an automatic stabilizer. If fiscal policy maintains the provision of public goods per capita constant, the slowdown gives rise to a pleasant fiscal arithmetic, requiring tax cuts or a higher target debt-to-output ratio for long-term fiscal sustainability. We discuss the ramifications of various fiscal strategies, including increasing per capita public spending, altering the tax structure, and adjusting the target debt-to-output ratio.

Keywords: Open economy; Trend growth; Fiscal policy; Real business cycles; Estimation; Structural breaks (search for similar items in EconPapers)
JEL-codes: E30 F43 H30 (search for similar items in EconPapers)
Date: 2024
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Working Paper: The Fiscal Arithmetic of a Slowdown in Trend Growth (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:168:y:2024:i:c:s0014292124001351

DOI: 10.1016/j.euroecorev.2024.104806

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