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Fiscal Austerity in Emerging Market Economies

Author

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  • Dave, Chetan

    (University of Alberta, Department of Economics)

  • Ghate, Chetan

    (Indian Statistical Institute)

  • Gopalakrishnan, Pawan

    (Reserve Bank of India)

  • Tarafdar, Suchismita

    (Shiv Nadar University)

Abstract

We build a small open economy RBC model with financial frictions to analyze the incidence of expansionary fiscal consolidations in emerging market economies (EMEs). We calibrate the model to India, a proto-typical EME. We show that a spending based fiscal consolidation has an expansionary effect on output. In contrast, tax based consolidations are always contractionary. Either measure of consolidation, however, tends to increase the fiscal deficit and therefore the sovereign risk premia in our framework. Our findings support the results in the IMF WEO (2010), that tax based consolidation measures are more costly (in terms of GDP losses) than spending based consolidations in the short run. We identify new mechanisms that underlie the dynamics of fiscal reforms and their implications for successful fiscal consolidations.

Suggested Citation

  • Dave, Chetan & Ghate, Chetan & Gopalakrishnan, Pawan & Tarafdar, Suchismita, 2019. "Fiscal Austerity in Emerging Market Economies," Working Papers 2019-5, University of Alberta, Department of Economics.
  • Handle: RePEc:ris:albaec:2019_005
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    More about this item

    Keywords

    Expansionary Fiscal Consolidations; Fiscal Policy in Small Open Economies; Emerging Market Business Cycles; Financial Frictions;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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