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The macroeconomics of fiscal consolidations in a monetary union: the case of Italy

  • Lorenzo Forni

    ()

    (Bank of Italy)

  • Andrea Gerali

    ()

    (Bank of Italy)

  • Massimiliano Pisani

    ()

    (Bank of Italy JEL classification: E62, H63)

We simulate the macroeconomic and welfare implications of different fiscal consolidation scenarios in Italy using a medium scale two-areas dynamic general equilibrium currency-union model. Differently from similar models, ours is rich in the terms of fiscal features. We assume distortionary taxes (on labor income, capital income and consumption) and welfare-enhancing public expenditure. We distinguish between public spending on final goods and services, public employment and transfers to households. The scenarios that we consider envisage a decreases in the public debt to GDP ratio of 10 percentage points in 5 years. Based on our simulations we find that: first, fiscal distortions are quantitatively significant; second, a consolidation strategy that reduces expenditure and simultaneously lowers tax rates has a positive effect on long-run GDP of 5% to 7% and on welfare of 4% to 7% of the initial levels, depending on the composition of the adjustment; third, consumption and investment are stable or grow on impact and along the path to the new steady state; finally, spillovers to the rest of the Euro area are expansionary and sizeable both in the long run and along the transition.

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Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 747.

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Date of creation: Mar 2010
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Handle: RePEc:bdi:wptemi:td_747_10
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Web page: http://www.bancaditalia.it

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