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Fiscal consolidation, public debt and output dynamics in the euro area : lessons from a simple model with time-varying fiscal multipliers

Listed author(s):
  • Christophe Blot

    (OFCE Sciences Po)

  • Marion Cochard

    (OFCE Sciences Po)

  • Bruno Ducoudré

    (Ofce,Sciences Po)

  • Danielle Schweisguth

    (OFCE Sciences Po)

  • Xavier Timbeau

    (OFCE Sciences Po)

  • Jérôme Creel

    (OFCE Sciences Po, ESCP Europe)

EMU countries have engaged in a consolidation of fiscal policies since 2011. This paper deals with the public debt and output dynamic consequences of this strategy. To thisend, we develop a simple macroeconomic modelof the Euro area, where fiscal multipliers time-varying. Recent empirical evidence has indeed shown that fiscal multipliers werehigher in time of crisis. We then analyze the ability of EMU countries to comply with thenew fiscal rules on public debt. he path of public debt and output gap is simulated according to different hypothesis related to fiscal multiplier, monetary policy andhysteresis effects. Not all EMU countries would be able to reach a 60% debt-to-GDP ratio in 2032. An alternative strategy may be to spread austerity in order to report part of consolidation to periods where the fiscal multiplier will be weaker. The gain of spreading austerity may yet be partly offset by higher risk premium. There is then a need to find institutional arrangements to avoid panics in the sovereign debt markets. Finally, it is shown that it would not be very efficient to implement an expansionary fiscal policy in Germany in order to balance austerity in the Euro area. Since output gap is nearly closed in Germany, the multiplier effect of a positive fiscal stance would be low and spillover effects would not be significant

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File URL: http://www.ofce.sciences-po.fr/pdf/dtravail/WP2014-14.pdf
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Paper provided by Observatoire Francais des Conjonctures Economiques (OFCE) in its series Documents de Travail de l'OFCE with number 2014-14.

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Date of creation: Jul 2014
Handle: RePEc:fce:doctra:1414
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