The Effects of Fiscal Consolidation in the Czech Republic

This paper uses the IMF’s Global Integrated Monetary and Fiscal Model (GIMF) to assess the impact of fiscal consolidation on the Czech economy. Its contribution is threefold. First, it provides estimates of dynamic fiscal multipliers for a variety of fiscal instruments (tax and expenditure), consolidation durations, assumptions about credibility, and monetary policy responses. Second, the paper evaluates the impact on the economy of tightening measures envisaged in the 2011 budget. Third, the paper considers alternative packages for consolidation beyond 2011 to achieve the government’s target of zero deficit by 2016 to identify which forms of adjustment are more “growth-friendly.” The paper uses simulations of a two-country version of the Global Monetary and Fiscal Model (GIMF) calibrated to the Czech Republic and the European Union.The fiscal multiplier for the Czech Republic is quite small. It varies considerably across instruments. Higher credibility generally reduces the negative short-term impact of fiscal consolidation, while the inability of monetary policy to offset the fiscal shock increases it. The first-year multiplier for the adjustment package envisaged in the 2011 budget is about 1/3. Depending on the composition of future consolidation in line with government's objectives (balanced budget by 2016), both short-term and long-term impact on output varies dramatically.