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Fiscal Consolidation in an Open Economy with Sovereign Premia and without Monetary Policy Independence

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  • Apostolis Philippopoulos

    (Athens University of Economics and Business, CESifo)

  • Petros Varthalitis

    (Economic and Social Research Institute, Trinity College Dublin)

  • Vanghelis Vassilatos

    (Athens University of Economics and Business, CESifo)

Abstract

We welfare rank various tax-spending-debt policies in a New Keynesian model of a small open economy featuring sovereign interest rate premia and loss of monetary policy independence. When we compute optimized state-contingent policy rules, our results are as follows: (i) Debt consolidation comes at a short-term pain, but the medium- and long-term gains can be substantial. (ii) In the early phase of pain, the best fiscal policy mix is to cut public consumption spending to address the debt problem and, at the same time, to cut income tax rates to mitigate the recessionary effects of debt consolidation. (iii) In the long run, the best way of using the fiscal space created is to reduce capital taxes.

Suggested Citation

  • Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2017. "Fiscal Consolidation in an Open Economy with Sovereign Premia and without Monetary Policy Independence," International Journal of Central Banking, International Journal of Central Banking, vol. 13(4), pages 259-306, December.
  • Handle: RePEc:ijc:ijcjou:y:2017:q:4:a:8
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    1. repec:eee:dyncon:v:83:y:2017:i:c:p:55-106 is not listed on IDEAS
    2. Philippopoulos, Apostolis & Varthalitis, Petros & Vassilatos, Vanghelis, 2017. "Fiscal consolidation and its cross-country effects," Journal of Economic Dynamics and Control, Elsevier, vol. 83(C), pages 55-106.
    3. George Economides & Anastasios Xepapadeas, 2018. "Monetary Policy under Climate Change," CESifo Working Paper Series 7021, CESifo Group Munich.
    4. George Economides & Anastasios Xepapadeas, 2018. "Monetary policy under climate change," Working Papers 247, Bank of Greece.

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    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • F3 - International Economics - - International Finance
    • H6 - Public Economics - - National Budget, Deficit, and Debt

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