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The macroeconomics of fiscal consolidations in a monetary union: the case of Italy

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Author Info

  • Lorenzo Forni

    () (Bank of Italy)

  • Andrea Gerali

    () (Bank of Italy)

  • Massimiliano Pisani

    () (Bank of Italy JEL classification: E62, H63)

Abstract

We simulate the macroeconomic and welfare implications of different fiscal consolidation scenarios in Italy using a medium scale two-areas dynamic general equilibrium currency-union model. Differently from similar models, ours is rich in the terms of fiscal features. We assume distortionary taxes (on labor income, capital income and consumption) and welfare-enhancing public expenditure. We distinguish between public spending on final goods and services, public employment and transfers to households. The scenarios that we consider envisage a decreases in the public debt to GDP ratio of 10 percentage points in 5 years. Based on our simulations we find that: first, fiscal distortions are quantitatively significant; second, a consolidation strategy that reduces expenditure and simultaneously lowers tax rates has a positive effect on long-run GDP of 5% to 7% and on welfare of 4% to 7% of the initial levels, depending on the composition of the adjustment; third, consumption and investment are stable or grow on impact and along the path to the new steady state; finally, spillovers to the rest of the Euro area are expansionary and sizeable both in the long run and along the transition.

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Bibliographic Info

Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 747.

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Date of creation: Mar 2010
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Handle: RePEc:bdi:wptemi:td_747_10

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Postal: Via Nazionale, 91 - 00184 Roma
Web page: http://www.bancaditalia.it
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Related research

Keywords: fiscal consolidation; monetary union; distortionary taxation; general equilibrium models;

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Cited by:
  1. L. Marattin & M. Marzo, 2010. "The Multiplier-Effects of Non-Wasteful Government Expenditure," Working Papers 704, Dipartimento Scienze Economiche, Universita' di Bologna.
  2. Thibault Guyon & Benjamin Carton, 2012. "Désendettement en union monétaire : un modèle structurel," Économie et Statistique, Programme National Persée, vol. 451(1), pages 131-153.
  3. Vito Tanzi, 2011. "The Return to Fiscal Rectitude After the Recent Escapade," Rivista di Politica Economica, SIPI Spa, issue 3, pages 253-277, JULY-SEPT.
  4. Bertrand Gruss & Jose L. Torres, 2012. "Macroeconomic and Welfare Costs of U.S. Fiscal Imbalances," IMF Working Papers 12/38, International Monetary Fund.

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