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Restrictive Fiscal Policies in Europe: What are the Likely Effects?

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  • C. KERDRAIN

    (Insee)

  • V. LAPÈGUE

    (Insee)

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    Abstract

    In Europe, fiscal policy will be distinctly more restrictive from 2011 onwards. The fiscal consolidation efforts scheduled for 2011 represent 1.2 percentage points of GDP in the eurozone and 1.8 percentage points in the UK. Such adjustments hit short-term demand and depress activity by Keynesian effects. However, non-Keynesian mechanisms can attenuate them, not least through expectations and supply effects. The impact of fiscal consolidation is also related to the economic background: in line with the recent developments on sovereign bond markets, fiscal variables are found to have a significant impact on interest rate spreads on euro area public bonds. According to our main result, when debt exceeds 100 percentage points of GDP, the marginal effect on the spread of one additional point of debt would be about 7 to 8 basis points. Accordingly, fiscal consolidation is likely to weigh down on euro area sovereign risk premiums. In this light, the NiGEM international macroeconomic model is used to assess the GDP impact of European fiscal consolidation plans. Overall, euro area's GDP in 2011 is estimated to have been 0.6% lower than in a scenario without fiscal consolidation. This impact may however be an upper bound: these simulations do not take account of the possibility of a sudden increase of financial distress following a major loss of confidence in the sovereign bonds of some euro area countries.

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    File URL: http://www.insee.fr/en/publications-et-services/docs_doc_travail/G2011-17.pdf
    File Function: Document de travail de la DESE numéro G2011-17
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    Bibliographic Info

    Paper provided by Institut National de la Statistique et des Etudes Economiques, DESE in its series Documents de Travail de la DESE - Working Papers of the DESE with number g2011-17.

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    Date of creation: 2011
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    Handle: RePEc:crs:wpdeee:g2011-17

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    Keywords: Fiscal consolidation; sovereign risk spread; eurozone;

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    1. Silvia Ardagna & Francesco Caselli & Timothy Lane, 2004. "Fiscal Discipline and the Cost of Public Debt Service: Some Estimates for OECD Countries," NBER Working Papers 10788, National Bureau of Economic Research, Inc.
    2. Oliver Röhn, 2010. "New Evidence on the Private Saving Offset and Ricardian Equivalence," OECD Economics Department Working Papers 762, OECD Publishing.
    3. Carmen M. Reinhart & Kenneth S. Rogoff, 2010. "Growth in a Time of Debt," NBER Working Papers 15639, National Bureau of Economic Research, Inc.
    4. Heylen, Freddy & Everaert, Gerdie, 2000. " Success and Failure of Fiscal Consolidation in the OECD: A Multivariate Analysis," Public Choice, Springer, vol. 105(1-2), pages 103-24, October.
    5. Ardagna, Silvia, 2004. "Fiscal Stabilizations: When Do They Work and Why," Scholarly Articles 2580047, Harvard University Department of Economics.
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