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The sectoral reallocation of government purchases as budgetary-neutral stabilisation tool: a model-based analysis

Stefan Hohberger (), Lukas Vogel () and Bernhard Herz ()

International Economics and Economic Policy, 2015, vol. 12, issue 1, 59-74

Abstract: The paper uses a two-sector DSGE model with nominal and real rigidities to analyse the stabilising properties of fiscal policy rules in a small open economy in monetary union. The focus is on the potential of budgetary-neutral rules that adjust the composition of government purchases between tradable and non-tradable goods in response to business cycle indicators as a stabilisation tool when fiscal limits are tight. The paper finds that the state-dependent reallocation of government purchases between tradable and non-tradable goods stabilises domestic activity and reduces the welfare costs of economy-wide and sector-specific shocks. Potential welfare gains from such policy rules are higher than welfare gains from standard counter-cyclical fiscal policy rules that adjust the overall level of government purchases. Contrary to standard deficit spending policies, the state-dependent expenditure composition rules avoid the trade-off between, first, counter-cyclical spending and, second, consolidation needs in economic downturns in the presence of explicit or implicit deficit and debt limits. Copyright Springer-Verlag Berlin Heidelberg 2015

Keywords: Fiscal policy; Stabilisation; Welfare; Tradables; Non-tradables; Small open economy; Monetary union; E37; E62; F41 (search for similar items in EconPapers)
Date: 2015
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DOI: 10.1007/s10368-014-0280-0

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