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Automatic stabilizers, fiscal rules and macroeconomic stability

  • Andres, Javier
  • Domenech, Rafael

This paper analyzes the effect of the fiscal structure upon the trade-off between inflation and output stabilization in the presence of technological shocks in a DGE model with nominal and real rigidities. The model reproduces the main features of European economies and it integrates a rich menu of fiscal variables as well as a target on the debt to output ratio. The main result of this paper is that distortionary taxes tend to increase output volatility relative to lump-sum taxes unless substantial rigidities are present. We explore in detail the mechanisms that generate such a result, and the conditions under which the supply-side effects of distortionary taxes and the procyclical behaviour of public spending induced by fiscal rules prevail over the conventional effect of automatic stabilizers operating through disposable income.

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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 50 (2006)
Issue (Month): 6 (August)
Pages: 1487-1506

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Handle: RePEc:eee:eecrev:v:50:y:2006:i:6:p:1487-1506
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