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Fiscal Consolidation Strategy: An Update for the Budget Reform Proposal of March 2013

Listed author(s):
  • John Cogan

    ()

    (Hoover Institute)

  • John Taylor

    ()

    (Stanford University)

  • Volker Wieland

    ()

    (Goethe University Frankfurt)

  • Maik Wolters

    ()

    (Kiel University)

Recently, we evaluated a fiscal consolidation strategy for the United States that would bring the government budget into balance by gradually reducing government spending relative to GDP to the ratio that prevailed prior to the crisis (Cogan et al, JEDC 2013). Specifically, we published an analysis of the macroeconomic consequences of the 2013 Budget Resolution that was passed by the U.S. House of Representatives in March 2012. In this note, we provide an update of our research that evaluates this year’s budget reform proposal that is to be discussed and voted on in the House of Representative in March 2013. Contrary to the views voiced by critics of fiscal consolidation, we show that such a reduction in government purchases and transfer payments can increase GDP immediately and permanently relative to a policy without spending restraint. Our research makes use of a modern structural model of the economy that incorporates the long-standing essential features of economics: opportunity costs, efficiency, foresight and incentives. GDP rises because households take into account that spending restraint helps avoid future increases in tax rates. Lower taxes imply less distorted incentives for work, investment and production relative to a scenario without fiscal consolidation and lead to higher growth.

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File URL: http://www-siepr.stanford.edu/repec/sip/12-033.pdf
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Paper provided by Stanford Institute for Economic Policy Research in its series Discussion Papers with number 12-033.

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Date of creation: Mar 2013
Handle: RePEc:sip:dpaper:12-033
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  1. John B. Taylor & Volker Wieland, 2012. "Surprising Comparative Properties of Monetary Models: Results from a New Model Database," The Review of Economics and Statistics, MIT Press, vol. 94(3), pages 800-816, August.
  2. Fabio Verona, 2011. "Lumpy investment in sticky information general equilibrium," CEF.UP Working Papers 1102, Universidade do Porto, Faculdade de Economia do Porto.
  3. Wieland, Volker & Wolters, Maik, 2013. "Forecasting and Policy Making," Handbook of Economic Forecasting, Elsevier.
  4. Cogan, John F. & Cwik, Tobias & Taylor, John B. & Wieland, Volker, 2010. "New Keynesian versus old Keynesian government spending multipliers," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 281-295, March.
  5. F. Verona & M. M. F. Martins & I. Drumond, 2013. "(Un)anticipated Monetary Policy in a DSGE Model with a Shadow Banking System," International Journal of Central Banking, International Journal of Central Banking, vol. 9(3), pages 78-124, September.
  6. Sebastian Schmidt, 2013. "Optimal Monetary and Fiscal Policy with a Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(7), pages 1335-1350, October.
  7. Wolters Maik H. & Tillmann Peter, 2015. "The changing dynamics of US inflation persistence: a quantile regression approach," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 19(2), pages 161-182, April.
  8. Cogan, John F. & Taylor, John B. & Wieland, Volker & Wolters, Maik H., 2013. "Fiscal consolidation strategy," Journal of Economic Dynamics and Control, Elsevier, vol. 37(2), pages 404-421.
  9. Wieland, Volker & Cwik, Tobias & Müller, Gernot J. & Schmidt, Sebastian & Wolters, Maik, 2012. "A new comparative approach to macroeconomic modeling and policy analysis," Journal of Economic Behavior & Organization, Elsevier, vol. 83(3), pages 523-541.
  10. Coenen, Günter & McAdam, Peter & Straub, Roland, 2008. "Tax reform and labour-market performance in the euro area: A simulation-based analysis using the New Area-Wide Model," Journal of Economic Dynamics and Control, Elsevier, vol. 32(8), pages 2543-2583, August.
  11. Juillard, Michel, 1996. "Dynare : a program for the resolution and simulation of dynamic models with forward variables through the use of a relaxation algorithm," CEPREMAP Working Papers (Couverture Orange) 9602, CEPREMAP.
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