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What is the Price of Austerity? – A Dynamic AGE-analysis for Finland

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  • Honkatukia, Juha
  • Tamminen, Saara

Abstract

The current economic turmoil within the Euro area has brought fiscal stance at the core of economic debate. In most EU countries public deficits have increased and different types of “austerity packages” are considered. Typically these packages consist of tax increases and public spending cuts. In this study we assess the effects of planned Finnish public spending cuts on the local economy, on fiscal sustainability and on income inequality in short and long run. We use a dynamic AGE model to estimate the effects. The model has been extended in two major respects for the analysis of these welfare effects. First, the model covers income decile-specific employment/leisure and saving choices. Second, it takes into consideration the direct welfare effects of government spending on households. To evaluate the welfare effects of public services provision, we use recent data on income decile-specific, non-market consumption of public services. This allows us to study the welfare effects of cuts in specific, publicly provided services. We calculate the dynamic Marginal Cost of Funds (MCF) and the effects on income inequality. Our central finding is that the welfare costs, and thus the plausibility of the austerity package, depend on the type of the public spending cuts. When spending cuts concern public services that are of indirect use to the consumers, welfare effects are negligible. If public services that do provide direct utility are cut, welfare is affected much more strongly. In general, the Finnish austerity package is found to be even welfare improving according to the dynamic MCF calculations. However, it increases slightly income inequality between households.

Suggested Citation

  • Honkatukia, Juha & Tamminen, Saara, 2012. "What is the Price of Austerity? – A Dynamic AGE-analysis for Finland," Conference papers 332274, Purdue University, Center for Global Trade Analysis, Global Trade Analysis Project.
    • Handle: RePEc:ags:pugtwp:332274
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    References listed on IDEAS

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