The macroeconomics of fiscal consolidations in a monetary union: the case of Italy

Lorenzo Forni, Andrea Gerali () and Massimiliano Pisani

No 747, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: We simulate the macroeconomic and welfare implications of different fiscal consolidation scenarios in Italy using a medium scale two-areas dynamic general equilibrium currency-union model. Differently from similar models, ours is rich in the terms of fiscal features. We assume distortionary taxes (on labor income, capital income and consumption) and welfare-enhancing public expenditure. We distinguish between public spending on final goods and services, public employment and transfers to households. The scenarios that we consider envisage a decreases in the public debt to GDP ratio of 10 percentage points in 5 years. Based on our simulations we find that: first, fiscal distortions are quantitatively significant; second, a consolidation strategy that reduces expenditure and simultaneously lowers tax rates has a positive effect on long-run GDP of 5% to 7% and on welfare of 4% to 7% of the initial levels, depending on the composition of the adjustment; third, consumption and investment are stable or grow on impact and along the path to the new steady state; finally, spillovers to the rest of the Euro area are expansionary and sizeable both in the long run and along the transition.

Keywords: fiscal consolidation; monetary union; distortionary taxation; general equilibrium models (search for similar items in EconPapers)
Date: 2010-03
New Economics Papers: this item is included in nep-dge and nep-mac
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Citations: View citations in EconPapers (15)

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Related works:
Working Paper: The macroeconomics of fiscal consolidations in a Monetary Union: the case of Italy (2008)
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