Fiscal Consolidation in a Small Euro Area Economy
AbstractThis 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 InfoPaper provided by Banco de Portugal, Economics and Research Department in its series Working Papers with number w201105.
Date of creation: 2011
Date of revision:
Other versions of this item:
- Vanda Almeida & Gabriela Lopes de Castro & Ricardo Mourinho Félix & José R. Maria, 2011. "Fiscal consolidation in a small euro area economy," Economic Bulletin and Financial Stability Report Articles, Banco de Portugal, Economics and Research Department.
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
- H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-04-02 (All new papers)
- NEP-CBA-2011-04-02 (Central Banking)
- NEP-DGE-2011-04-02 (Dynamic General Equilibrium)
- NEP-EEC-2011-04-02 (European Economics)
- NEP-MAC-2011-04-02 (Macroeconomics)
- NEP-PBE-2011-04-02 (Public Economics)
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