Fiscal consolidation in the euro area: long-run benefits and short-run costs

Matthias Mohr, Roland Straub and Günter Coenen

No 902, Working Paper Series from European Central Bank

Abstract: In this paper, we examine the macroeconomic effects of alternative fiscal consolidation policies in the New Area-Wide Model (NAWM), a two-country open-economy model of the euro area developed at the European Central Bank (cf. Coenen et al., 2007). We model fiscal consolidation as a permanent reduction in the targeted government debt-to-output ratio and analyse both expenditure and revenue-based policies that are implemented by means of simple fiscal feedback rules. We find that fiscal consolidation has positive long-run effects on key macroeconomic aggregates such as output and consumption, notably when the resulting improvement in the budgetary position is used to lower distortionary taxes. At the same time, fiscal consolidation gives rise to noticeable short-run adjustment costs in contrast to what the literature on expansionary fiscal consolidations suggests. Moreover, depending on the fiscal instrument used, fiscal consolidation may have pronounced distributional effects. JEL Classification: E32, E62

Keywords: euro area; Fiscal consolidation; fiscal policy; Keywords: DSGE modelling; limited asset-market participation (search for similar items in EconPapers)
Date: 2008-05
Note: 79802
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (117)

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Journal Article: Fiscal consolidation in the euro area: Long-run benefits and short-run costs (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:2008902

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