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Fiscal Consolidation Under Imperfect Credibility

Matthieu Lemoine () and Jesper Lindé

Working papers from Banque de France

Abstract: This paper examines the effects of expenditure-based fiscal consolidation when credibility as to whether the cuts will be long-lasting is imperfect. We contrast the impact limited credibility has when the consolidating country has the means to tailor monetary policy to its own needs, with the impact when the country is a small member of a currency union with a negligible effect on interest rates and on nominal exchange rates of the currency union. We find two key results. First, in the case of an independent monetary policy, the adverse impact of limited credibility is relatively small, and consolidation can be expected to reduce government debt at a relatively low output cost given that monetary policy provides more accommodation than it would under perfect credibility. Second, the lack of monetary accommodation under currency union membership implies that the output cost may be significantly larger, and that progress in reducing government debt in the short and medium term may be limited under imperfect credibility.

Keywords: monetary and fiscal policy; front-loaded vs. gradual consolidation; DSGE model; sticky prices and wages; currency union. (search for similar items in EconPapers)
JEL-codes: E32 F41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-eec, nep-mac and nep-opm
Date: 2016
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Citations: View citations in EconPapers (9) Track citations by RSS feed

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Journal Article: Fiscal consolidation under imperfect credibility (2016) Downloads
Working Paper: Fiscal Consolidation Under Imperfect Credibility (2016) Downloads
Working Paper: Fiscal Consolidation Under Imperfect Credibility (2016) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:595

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