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To React or Not? Fiscal Policy, Volatility and Welfare in the EU-3

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  • Jim Malley
  • Apostolis Philippopoulos
  • Ulrich Woitek

Abstract

This paper develops a dynamic stochastic general equilibrium model to examine the quantitative macroeconomic implications of counter- cyclical fiscal policy for France, Germany and the UK. The model incorporates real wage rigidity which is the particular market failure justifying policy intervention. We subject the model to productivity shocks and use either government consumption or investment to react to the output gap or the public debt-to-output ratio. If the object of fiscal policy is purely to stabilize output or debt volatility, then our results suggest substantial reductions can be obtained, especially with respect to output. In stark contrast, however, a formal general equilibrium welfare assessment of the volatility implications of these alternative instrument/target combinations reveals the welfare gains from active policy, measured as a share of consumption, to be very modest.

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Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 312.

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Date of creation: Feb 2007
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Handle: RePEc:zur:iewwpx:312

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Keywords: Fiscal Policy; Welfare; Europe;

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Cited by:
  1. Papageorgiou, Dimitris, 2012. "Fiscal policy reforms in general equilibrium: The case of Greece," Journal of Macroeconomics, Elsevier, Elsevier, vol. 34(2), pages 504-522.

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