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Good and bad equilibria. What can fiscal (and other) policies do?

Author

Listed:
  • Pier Carlo Padoan
  • Urban Sila
  • Paul van den Noord

Abstract

Fiscal consolidation will go too far if it pushes the economy towards a ?bad equilibrium? with high and growing fiscal deficits and debt, high risk premia on sovereign debt, slumping economic activity and plummeting confidence. In this paper we examine the possible conditions under which fiscal consolidation would backfire in this sense. For this purpose we develop a stylised stock-flow model of public debt and growth, which we subsequently calibrate empirically on a sample of OECD countries. We find that, if the sovereign risk premium is initially high, fiscal consolidation will help a country to escape from a ?bad equilibrium?, not push it toward it, even if the direct negative demand impact of fiscal consolidation is large. In that case the stabilising impact of structural reform and financial backstops will also be larger than under normal market conditions. JEL Classification: E62, C33, C62.

Suggested Citation

  • Pier Carlo Padoan & Urban Sila & Paul van den Noord, 2013. "Good and bad equilibria. What can fiscal (and other) policies do?," Revue de l'OFCE, Presses de Sciences-Po, vol. 0(1), pages 369-388.
    • Handle: RePEc:cai:reofsp:reof_127_0369
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    Cited by:

    1. Barbara Annicchiarico & Fabio Di Dio & Stefano Patrì, 2023. "Optimal correction of the public debt and measures of fiscal soundness," Metroeconomica, Wiley Blackwell, vol. 74(1), pages 138-162, February.

    More about this item

    Keywords

    fiscal policy; sovereign debt; multiple equilibria;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium

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