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Fiscal consolidation: Dr Pangloss meets Mr Keynes

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  • Miller, Marcus

    (University of Warwick)

  • Zhang, Lei

    (University of Warwick)

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    Abstract

    A simple dynamic framework is used to show how consolidation plans that are robust and effective at capacity output can be undermined by demand failure. If the market panics and interest rates rise, the process can indeed become dynamically unstable. Tightening fiscal policy to reassure financial markets can lead to a low level “consolidation trap”, however. Better that the Central Bank acts to keep interest rates low; and that fiscal consolidation efforts be state contingent – allowing room for economic stabilisation. The pro-cyclicality of fiscal policy could also be reduced if, as Shiller has argued, debt amortization were state contingent, being indexed to GDP. Debt; Deficits; Fiscal Consolidation; Economic Stabilisation

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    Bibliographic Info

    Paper provided by Competitive Advantage in the Global Economy (CAGE) in its series CAGE Online Working Paper Series with number 159.

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    Date of creation: 2013
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    Handle: RePEc:cge:wacage:159

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    1. Atish R. Ghosh & Jun I. Kim & Enrique G. Mendoza & Jonathan D. Ostry & Mahvash S. Qureshi, 2011. "Fiscal Fatigue, Fiscal Space and Debt Sustainability in Advanced Economies," NBER Working Papers 16782, National Bureau of Economic Research, Inc.
    2. Luc Eyraud & Anke Weber, 2013. "The Challenge of Debt Reduction during Fiscal Consolidation," IMF Working Papers 13/67, International Monetary Fund.
    3. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-61, September.
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    Cited by:
    1. Barr, David & Bush, Oliver & Pienkowski, Alex, 2014. "GDP-linked bonds and sovereign default," Bank of England working papers 484, Bank of England.

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