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Macroeconomic effects of fiscal consolidations in a DSGE model for the Euro Area: does composition matter?

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  • Vitor M. Carvalho

    ()
    (CEF.UP, Faculdade de Economia do Porto, Universidade do Porto)

  • Manuel M. F. Martins

    ()
    (CEF.UP, Faculdade de Economia do Porto, Universidade do Porto)

Abstract

We develop a new-Keynesian DSGE model with an extended fiscal policy block to assess the conditions for expansionary fiscal consolidations. In addition to several taxes, we consider public employment expenditures and government spending, which may have different degrees of productivity. We calibrate the model for the Euro Area and use it to simulate alternative fiscal consolidations with changes in the budget composition. Among the main conclusions we find that: (i) if conducted with a cut in weaklyproductive spending and a symmetric increase in highly-productive spending, fiscal consolidations have expansionary effects on investment and output; (ii) if consolidation is pursued through a pure reduction in weaklyproductive public employment, the effects on output decrease with the degree of labor market competition and turn out to be positive under perfect competition.

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Bibliographic Info

Paper provided by Universidade do Porto, Faculdade de Economia do Porto in its series FEP Working Papers with number 421.

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Length: 44 pages
Date of creation: Jul 2011
Date of revision:
Handle: RePEc:por:fepwps:421

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Keywords: fiscal policy; fiscal consolidation; new-Keynesian DSGE model;

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