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Deficit reduction: Short-term pain for long-term gain

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Author Info

  • Clinton, Kevin
  • Kumhof, Michael
  • Laxton, Douglas
  • Mursula, Susanna

Abstract

The paper evaluates the costs and benefits of fiscal consolidation using simulations based on the IMFs global dynamic general equilibrium model GIMF. Over the longer run, well-targeted permanent reductions in budget deficits can lead to a considerable increase in both the growth rate and the level of output. The gains may be enhanced by shifting some of the tax burden from incomes to consumption. In the short-run, credibility plays a crucial role in determining the size of initial output losses. Global current account imbalances would be significantly reduced if budget consolidation was larger in countries with current account deficits.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 55 (2011)
Issue (Month): 1 (January)
Pages: 118-139

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Handle: RePEc:eee:eecrev:v:55:y:2011:i:1:p:118-139

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Web page: http://www.elsevier.com/locate/eer

Related research

Keywords: Fiscal consolidation Fiscal stimulus Crowding-out Current account imbalances Tax reform;

References

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  1. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Optimal Fiscal and Monetary Policy Under Sticky Prices," NBER Working Papers 9220, National Bureau of Economic Research, Inc.
  2. Christiano, Lawrence & Rostagno, Massimo & Motto, Roberto, 2010. "Financial factors in economic fluctuations," Working Paper Series 1192, European Central Bank.
  3. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers 98-03, C.V. Starr Center for Applied Economics, New York University.
  4. Juillard, Michel & Laxton, Douglas & McAdam, Peter & Pioro, Hope, 1998. "An algorithm competition: First-order iterations versus Newton-based techniques," Journal of Economic Dynamics and Control, Elsevier, vol. 22(8-9), pages 1291-1318, August.
  5. Douglas Laxton & Susanna Mursula & Michael Kumhof & Dirk Muir, 2010. "The Global Integrated Monetary and Fiscal Model (GIMF) – Theoretical Structure," IMF Working Papers 10/34, International Monetary Fund.
  6. Jordi Galí & Tommaso Monacelli, 2005. "Optimal monetary and fiscal policy in a currency union," Economics Working Papers 909, Department of Economics and Business, Universitat Pompeu Fabra, revised Feb 2008.
  7. Campbell Leith & Simon Wren-Lewis, 2006. "The Costs of Fiscal Inflexibility - Extended," Working Papers 2005_23, Business School - Economics, University of Glasgow.
  8. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-47, April.
  9. Campbell Leith & Simon Wren-lewis, 2006. "The Costs of Fiscal Inflexibility," WEF Working Papers 0005, ESRC World Economy and Finance Research Programme, Birkbeck, University of London.
  10. Ganelli, Giovanni, 2003. "The New Open Economy Macroeconomics of Government Debt," Royal Economic Society Annual Conference 2003 83, Royal Economic Society.
  11. William G. Gale & Peter R. Orszag, 2004. "Budget Deficits, National Saving, and Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 35(2), pages 101-210.
  12. Nathalie Girouard & Christophe André, 2005. "Measuring Cyclically-adjusted Budget Balances for OECD Countries," OECD Economics Department Working Papers 434, OECD Publishing.
  13. Thomas Laubach, 2003. "New evidence on the interest rate effects of budget deficits and debt," Finance and Economics Discussion Series 2003-12, Board of Governors of the Federal Reserve System (U.S.).
  14. S. Rao Aiyagari & Albert Marcet & Thomas J. Sargent & Juha Seppala, 2002. "Optimal Taxation without State-Contingent Debt," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1220-1254, December.
  15. Weil, Philippe, 1989. "Overlapping families of infinitely-lived agents," Journal of Public Economics, Elsevier, vol. 38(2), pages 183-198, March.
  16. Eric M. Engen & R. Glenn Hubbard, 2004. "Federal Government Debt and Interest Rates," NBER Working Papers 10681, National Bureau of Economic Research, Inc.
  17. Velculescu Delia, 2004. "Intergenerational Habits, Fiscal Policy, and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-34, September.
  18. Armstrong, John & Black, Richard & Laxton, Douglas & Rose, David, 1998. "A robust method for simulating forward-looking models," Journal of Economic Dynamics and Control, Elsevier, vol. 22(4), pages 489-501, April.
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Citations

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Cited by:
  1. Sampawende J.-A. Tapsoba, 2013. "Options and Strategies for Fiscal Consolidation in India," IMF Working Papers 13/127, International Monetary Fund.
  2. Gabriela Lopes de Castro & José R. Maria & Ricardo Mourinho Félix & Cláudia Braz, 2013. "Ageing and fiscal sustainability in a small euro area economy," Working Papers w201304, Banco de Portugal, Economics and Research Department.
  3. Vanda Almeida & Gabriela Lopes de Castro & Ricardo Mourinho Félix & José R. Maria, 2011. "Fiscal Consolidation in a Small Euro Area Economy," Working Papers w201105, Banco de Portugal, Economics and Research Department.
  4. Gianluca Cafiso & Roberto Cellini, 2012. "Evidence on Fiscal Consolidations and the Evolution of Public Debt in Europe," CESifo Working Paper Series 4027, CESifo Group Munich.
  5. Gianluca Cafiso & Roberto Cellini, 2013. "Fiscal Consolidations and Public Debt in Europe," Working Papers 2013-35, CEPII research center.

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