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Fiscal consolidation in a small euro area economy

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  • Vanda Almeida
  • Gabriela Lopes de Castro
  • Ricardo Mourinho Félix
  • José R. Maria

Abstract

This article focuses on macroeconomic impacts and welfare effects of a fiscal consolidation process in a small euro-area economy. Fiscal consolidation is defined as a permanent decline in the ratio of public debt to GDP. The analysis is based on PESSOA, a New Keynesian general equilibrium model with non-Ricardian agents. The results suggest that a reduction in public expenditure leads in the long run to sizable increases in output and tends to improve welfare, specifically because it allows for a sustainable decrease in the labor income tax rate. However, output and consumption decline in the short run, and current generations are likely to experience welfare losses. This situation might well provide a rationale for the frequent lack of political will to move in this direction. The results are robust to alternative paths for fiscal consolidation.

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Bibliographic Info

Article provided by Banco de Portugal, Economics and Research Department in its journal Economic Bulletin.

Volume (Year): (2011)
Issue (Month): ()
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Handle: RePEc:ptu:bdpart:b201106

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Cited by:
  1. 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.
  2. Benjamin Carton, 2012. "Monetary-Policy Tradeoff in Overlapping Generations DSGE Models," DEM Working Papers Series 028, University of Pavia, Department of Economics and Management.
  3. Gabriela Lopes de Castro & Ricardo Mourinho Félix & Paulo Júlio & José R. Maria, 2013. "Fiscal multipliers in a small euro area economy: How big can they get in crisis times?," Working Papers w201311, Banco de Portugal, Economics and Research Department.
  4. Thibault Guyon & Benjamin Carton, 2012. "Désendettement en union monétaire : un modèle structurel," Économie et Statistique, Programme National Persée, vol. 451(1), pages 131-153.

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