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Fiscal Austerity Measures: Spending Cuts vs. Tax Increases

  • Gerhard Glomm

    ()

    (Department of Economics, Indiana University - Bloomington)

  • Juergen Jung

    ()

    (Department of Economics, Towson University)

  • Chung Tran

    ()

    (Research School of Economics, The Australian National University)

We formulate an overlapping generations model with skill heterogeneity and productive and non-productive government programs to study the macroeconomic and intergenerational welfare effects caused by risk premium shocks and government debt reductions. We demonstrate that in a small open economy with a high level of debt-to-GDP ratio a small increase in the risk premium leads to substantial output contraction and negative welfare effects. Next, we quantify the effects of reducing the debt-to-GDP ratio using a wide range of fiscal austerity measures. These reforms result in trade-offs between short-run contractions and long-run expansions in aggregate output. In addition, the spending-based austerity reform is dominated by the tax-based reform in terms of income in the short run, but becomes dominant in the long run. The welfare effects vary significantly across generations, depending on fiscal austerity measures, skills and working sector. The current old and middle age generations experience welfare losses while current young workers and future generations are beneficiaries of the reforms. A mixed reform results in the largest welfare effects.

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File URL: http://www.towson.edu/cbe/economics/workingpapers/2013-01.pdf
File Function: First version, 2013
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Paper provided by Towson University, Department of Economics in its series Working Papers with number 2013-01.

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Length: 46 pages
Date of creation: Jan 2013
Date of revision: Aug 2013
Handle: RePEc:tow:wpaper:2013-01
Contact details of provider: Postal: Towson, Maryland 21252-0001
Phone: 410-704-2959
Fax: 410-704-3424
Web page: http://www.towson.edu/cbe/economics/

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