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Fiscal Consolidation in a Small Euro Area Economy

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  • Vanda Almeida
  • Gabriela Lopes de Castro
  • Ricardo Mourinho Félix
  • José R. Maria

Abstract

This article focuses on the costs and benefits of a fiscal consolidation in a small euro area economy. The macroeconomic impacts and the welfare analysis are conducted in a New-Keynesian general equilibrium model with non-Ricardian agents. We define a benchmark fiscal consolidation strategy based on a permanent reduction in Government expenditure. We find that, over the long run, fiscal consolidation leads to a considerable increase in the level of output and consumption, and is welfare improving. In addition, the gains are boosted if the fiscal strategy also involves a tax reform that shifts the tax burden away from labour income towards the final goods consumption. However, important short-run costs arise, notably output, consumption and welfare losses. Finally, we assess the effect of alternative fiscal consolidation paths in terms of the degree of front loading, the speed of its completion and the interaction with risk premium.

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Bibliographic Info

Paper provided by Banco de Portugal, Economics and Research Department in its series Working Papers with number w201105.

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Date of creation: 2011
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Handle: RePEc:ptu:wpaper:w201105

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Cited by:
  1. Gabriela Lopes de Castro & José R. Maria & Ricardo Mourinho Félix & Cláudia Braz, 2013. "Ageing and fiscal sustainability in a small euro area economy," Working Papers w201304, Banco de Portugal, Economics and Research Department.
  2. Gabriela Lopes de Castro & Ricardo Mourinho Félix & Paulo Júlio & José R. Maria, 2013. "Fiscal multipliers in a small euro area economy: How big can they get in crisis times?," Working Papers w201311, Banco de Portugal, Economics and Research Department.
  3. Benjamin Carton, 2012. "Monetary-Policy Tradeoff in Overlapping Generations DSGE Models," DEM Working Papers Series 028, University of Pavia, Department of Economics and Management.
  4. Thibault Guyon & Benjamin Carton, 2012. "Désendettement en union monétaire : un modèle structurel," Économie et Statistique, Programme National Persée, vol. 451(1), pages 131-153.

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