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Fiscal consolidation: Dr Pangloss meets Mr Keynes

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  • Miller, Marcus

    (University of Warwick)

  • Zhang, Lei

    (University of Warwick)

Abstract

A simple dynamic framework is used to show how consolidation plans that are robust and effective at capacity output can be undermined by demand failure. If the market panics and interest rates rise, the process can indeed become dynamically unstable. Tightening fiscal policy to reassure financial markets can lead to a low level “consolidation trap”, however. Better that the Central Bank acts to keep interest rates low; and that fiscal consolidation efforts be state contingent – allowing room for economic stabilisation. The pro-cyclicality of fiscal policy could also be reduced if, as Shiller has argued, debt amortization were state contingent, being indexed to GDP. Debt; Deficits; Fiscal Consolidation; Economic Stabilisation

Suggested Citation

  • Miller, Marcus & Zhang, Lei, 2013. "Fiscal consolidation: Dr Pangloss meets Mr Keynes," CAGE Online Working Paper Series 159, Competitive Advantage in the Global Economy (CAGE).
    • Handle: RePEc:cge:wacage:159
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    File URL: http://www2.warwick.ac.uk/fac/soc/economics/research/centres/cage/manage/publications/159-2013_miller.pdf
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    References listed on IDEAS

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    1. Barr, David & Bush, Oliver & Pienkowski, Alex, 2014. "GDP-linked bonds and sovereign default," Bank of England working papers 484, Bank of England.

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