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The (intertemporal) equity-efficiency trade-off of fiscal consolidation

Stelios Sakkas and Petros Varthalitis

MPRA Paper from University Library of Munich, Germany

Abstract: We build a dynamic general equilibrium model with heterogeneous households and capital-skill complementarity in the production function to study aggregate and distributional effects of fiscal consolidation policies when government uses a rich set of productivity-enhancing spending instruments along with utility-enhancing spending and tax fiscal instruments. Fiscal policy is conducted through simple fiscal rules. We study both ad-hoc and optimized fiscal rules. Our main results indicate that ad-hoc fiscal consolidation policies, either through spending cuts or tax increases, are recessionary and entail an equity-efficiency trade-off in the short- and medium-run. That is spending-based consolidation policies are less recessionary but come at a higher distributional cost; whereas tax-based consolidation policies result in sharper output losses but have smoother distributional effects. In addition, fiscal consolidation policies through optimized fiscal rules can be expansionary and social welfare enhancing while at the same time balance the equity-efficiency trade-off.

Keywords: Debt consolidation; distributional effects; fiscal policy; optimized fiscal rules (search for similar items in EconPapers)
JEL-codes: E62 H52 H53 (search for similar items in EconPapers)
Date: 2018-12-31
New Economics Papers: this item is included in nep-dge and nep-mac
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