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Fiscal consolidation: Dr Pangloss meets Mr Keynes


  • Miller, Marcus

    (University of Warwick)

  • Zhang, Lei

    (University of Warwick)


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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    References listed on IDEAS

    1. Atish R. Ghosh & Jun I. Kim & Enrique G. Mendoza & Jonathan D. Ostry & Mahvash S. Qureshi, 2013. "Fiscal Fatigue, Fiscal Space and Debt Sustainability in Advanced Economies," Economic Journal, Royal Economic Society, vol. 0, pages 4-30, February.
    2. Carmen M. Reinhart & Kenneth S. Rogoff, 2010. "Growth in a Time of Debt," American Economic Review, American Economic Association, vol. 100(2), pages 573-578, May.
    3. Barr, David & Bush, Oliver & Pienkowski, Alex, 2014. "GDP-linked bonds and sovereign default," Bank of England working papers 484, Bank of England.
    4. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-661, September.
    5. Dawn Holland & Jonathan Portes, 2012. "Self-Defeating Austerity?," National Institute Economic Review, National Institute of Economic and Social Research, vol. 222(1), pages 4-10, October.
    6. Luc Eyraud & Anke Weber, 2013. "The Challenge of Debt Reduction during Fiscal Consolidation," IMF Working Papers 13/67, International Monetary Fund.
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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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