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Fiscal Consolidation Strategy

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  • Cogan, John F.
  • Taylor, John B.
  • Wieland, Volker
  • Wolters, Maik H

Abstract

In the aftermath of the global financial crisis and great recession, many countries face substantial deficits and growing debts. In the United States, federal government outlays as a ratio to GDP rose substantially from about 19.5 percent before the crisis to over 24 percent after the crisis. In this paper we consider a fiscal consolidation strategy that brings the budget to balance by gradually reducing this spending ratio over time to the level that prevailed prior to the crisis. A crucial issue is the impact of such a consolidation strategy on the economy. We use structural macroeconomic models to estimate this impact. We consider two types of dynamic stochastic general equilibrium models: a neoclassical growth model and more complicated models with price and wage rigidities and adjustment costs. We separate out the impact of reductions in government purchases and transfers, and we allow for a reduction in both distortionary taxes and government debt relative to the baseline of no consolidation. According to the initial model simulations GDP rises in the short run upon announcement and implementation of this fiscal consolidation strategy and remains higher than the baseline in the long run.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9041.

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Date of creation: Jul 2012
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Handle: RePEc:cpr:ceprdp:9041

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Keywords: budget deficit; fiscal consolidation strategy; fiscal policy; government debt; U.S. budget;

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  1. Taylor, John B. & Wieland, Volker, 2012. "Surprising comparative properties of monetary models: Results from a new model database," IMFS Working Paper Series 66, Institute for Monetary and Financial Stability (IMFS), Goethe University Frankfurt.
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Cited by:
  1. Javier Andrés & J.E. Boscá & Javier Ferri, 2014. "Instruments, rules and household debt: the effects of fiscal policy," Working Papers, International Economics Institute, University of Valencia 1401, International Economics Institute, University of Valencia.
  2. Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2013. "Optimal Fiscal Action in an Economy with Sovereign Premia and without Monetary Independence: An Application to Italy," CESifo Working Paper Series 4199, CESifo Group Munich.
  3. Anthony J. Makin, 2013. "The policy (in)effectiveness of government spending in a dependent economy," Journal of Economic Policy Reform, Taylor & Francis Journals, Taylor & Francis Journals, vol. 16(3), pages 287-301, September.
  4. Reicher, Claire, 2014. "Systematic fiscal policy and macroeconomic performance: A critical overview of the literature," Economics Discussion Papers 2014-29, Kiel Institute for the World Economy.

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