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Fiscal austerity in emerging market economies

Author

Listed:
  • Dave Chetan

    (Department of Economics, University of AB, 9-18 Tory Building, Edmonton, T6G 2H4, AB, Canada)

  • Ghate Chetan

    (Economics and Planning Unit, Indian Statistical Institute, New Delhi, 110016, India)

  • Gopalakrishnan Pawan

    (Strategic Research Unit, Reserve Bank of India, Mumbai, 400001, India)

  • Tarafdar Suchismita

    (Department of Economics, Shiv Nadar University, Gautam Buddha Nagar, Noida, 201314, Uttar Pradesh, India)

Abstract

We build a small open economy RBC model with financial frictions to analyse spending and tax based fiscal consolidations in emerging market economies (EMEs). We show that if government spending is a substitute to private consumption in household utility, a spending based fiscal consolidation has an expansionary effect on output. In contrast, tax based consolidations are always contractionary irrespective of the strength of substitutability between government and private consumption. Our findings support the results in the World Economic Outlook (2010), USA: International Monetary Fund, that tax based consolidation measures are more costly (in terms of GDP losses) than spending based consolidations. We calibrate the model to India and calculate the fiscal multipliers associated with spending and tax based fiscal consolidations. Our paper identifies new mechanisms that underlie the dynamics of fiscal reforms and their implications for successful fiscal consolidations.

Suggested Citation

  • Dave Chetan & Ghate Chetan & Gopalakrishnan Pawan & Tarafdar Suchismita, 2021. "Fiscal austerity in emerging market economies," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 25(5), pages 365-391, December.
    • Handle: RePEc:bpj:sndecm:v:25:y:2021:i:5:p:365-391:n:2
    DOI: 10.1515/snde-2019-0042
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    More about this item

    Keywords

    emerging market business cycles; expansionary fiscal consolidations; financial frictions; fiscal policy in small open economies; the Indian economy;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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