IDEAS home Printed from https://ideas.repec.org/p/zbw/ifwkwp/1963.html
   My bibliography  Save this paper

The macroeconomic effects of fiscal consolidation in dynamic general equilibrium

Author

Listed:
  • Schwarzmüller, Tim
  • Wolters, Maik H.

Abstract

We provide a systematic analysis of fiscal consolidation in a medium-scale dynamic general equilibrium model. Our results show that the choice of the consolidation instrument is very important, not only with respect to the short- and long-run output effects of the different consolidation strategies, but also regarding the welfare effects and the distributional consequences. Moreover, we show that these aspects become even more important if fiscal consolidation has to be conducted at a binding zero lower bound on nominal interest rates because in this case the negative short-run output costs increase. Our comprehensive analysis of the transmission channels of various fiscal consolidation measures shows that in particular the presence of credit-constrained households who cannot smooth consumption has a large impact on the overall output and welfare effects of fiscal consolidation. Further, it turns out to be important whether a fiscal instrument directly affects private production factors negatively as it is the case for consolidation via government investment and taxes on labor and capital. In these cases the short-run output contraction is large and persistent because either the private or the public capital stock decreases. By contrast, for a consolidation via government consumption, transfers or the consumption tax rate, output recovers much faster.

Suggested Citation

  • Schwarzmüller, Tim & Wolters, Maik H., 2014. "The macroeconomic effects of fiscal consolidation in dynamic general equilibrium," Kiel Working Papers 1963, Kiel Institute for the World Economy (IfW Kiel).
    • Handle: RePEc:zbw:ifwkwp:1963
    as

    Download full text from publisher

    File URL: https://www.econstor.eu/bitstream/10419/103768/1/798982462.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Leeper, Eric M. & Plante, Michael & Traum, Nora, 2010. "Dynamics of fiscal financing in the United States," Journal of Econometrics, Elsevier, vol. 156(2), pages 304-321, June.
    2. Coenen, Günter & Straub, Roland & Trabandt, Mathias, 2013. "Gauging the effects of fiscal stimulus packages in the euro area," Journal of Economic Dynamics and Control, Elsevier, vol. 37(2), pages 367-386.
    3. Edward C. Prescott, 2004. "Why do Americans work so much more than Europeans?," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 28(Jul), pages 2-13.
    4. Òscar Jordà & Alan M. Taylor, 2016. "The Time for Austerity: Estimating the Average Treatment Effect of Fiscal Policy," Economic Journal, Royal Economic Society, vol. 126(590), pages 219-255, February.
    5. 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.
    6. Edward C. Prescott, 2002. "Prosperity and Depression: 2002 Richard T. Ely Lecture," Working Papers 618, Federal Reserve Bank of Minneapolis.
    7. Stähler, Nikolai & Thomas, Carlos, 2012. "FiMod — A DSGE model for fiscal policy simulations," Economic Modelling, Elsevier, vol. 29(2), pages 239-261.
    8. Angeloni, Ignazio & Faia, Ester & Winkler, Roland, 2014. "Exit strategies," European Economic Review, Elsevier, vol. 70(C), pages 231-257.
    9. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    10. Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2014. "Fiscal consolidation in an open economy with sovereign premia," Working Papers 201404, Athens University Of Economics and Business, Department of Economics.
    11. Coenen, Günter & Mohr, Matthias & Straub, Roland, 2008. "Fiscal consolidation in the euro area: Long-run benefits and short-run costs," Economic Modelling, Elsevier, vol. 25(5), pages 912-932, September.
    12. Lawrence Christiano & Martin Eichenbaum & Sergio Rebelo, 2011. "When Is the Government Spending Multiplier Large?," Journal of Political Economy, University of Chicago Press, vol. 119(1), pages 78-121.
    13. Brown, Jeffrey R. (ed.), 2010. "Tax Policy and the Economy, Volume 24," National Bureau of Economic Research Books, University of Chicago Press, number 9780226076737, July.
    14. Gunter Coenen & Roland Straub & Mathias Trabandt, 2012. "Fiscal Policy and the Great Recession in the Euro Area," American Economic Review, American Economic Association, vol. 102(3), pages 71-76, May.
    15. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
    16. Thorsten Drautzburg & Harald Uhlig, 2015. "Fiscal Stimulus and Distortionary Taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(4), pages 894-920, October.
    17. Alberto Alesina & Silvia Ardagna, 2010. "Large Changes in Fiscal Policy: Taxes versus Spending," NBER Chapters, in: Tax Policy and the Economy, Volume 24, pages 35-68, National Bureau of Economic Research, Inc.
    18. Werner Roeger & Jan in 't Veld, 2013. "Expected sovereign defaults and fiscal consolidations," European Economy - Economic Papers 2008 - 2015 479, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
    19. Hafedh Bouakez & Nooman Rebei, 2007. "Why does private consumption rise after a government spending shock?," Canadian Journal of Economics, Canadian Economics Association, vol. 40(3), pages 954-979, August.
    20. Raj Chetty & Adam Guren & Day Manoli & Andrea Weber, 2011. "Are Micro and Macro Labor Supply Elasticities Consistent? A Review of Evidence on the Intensive and Extensive Margins," American Economic Review, American Economic Association, vol. 101(3), pages 471-475, May.
    21. Giancarlo Corsetti & Keith Kuester & André Meier & Gernot J. Müller, 2013. "Sovereign Risk, Fiscal Policy, and Macroeconomic Stability," Economic Journal, Royal Economic Society, vol. 0, pages 99-132, February.
    22. Forni, Lorenzo & Gerali, Andrea & Pisani, Massimiliano, 2010. "The macroeconomics of fiscal consolidations in euro area countries," Journal of Economic Dynamics and Control, Elsevier, vol. 34(9), pages 1791-1812, September.
    23. Roberto Perotti, 2014. "Defense Government Spending Is Contractionary, Civilian Government Spending Is Expansionary," NBER Working Papers 20179, National Bureau of Economic Research, Inc.
    24. repec:ecb:ecbwps:20111429 is not listed on IDEAS
    25. Thorsten Drautzburg & Harald Uhlig, 2015. "Fiscal Stimulus and Distortionary Taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(4), pages 894-920, October.
    26. Vitor M. Carvalho & Manuel M. F. Martins, 2011. "Macroeconomic effects of fiscal consolidations in a DSGE model for the Euro Area: does composition matter?," FEP Working Papers 421, Universidade do Porto, Faculdade de Economia do Porto.
    27. 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.
    28. Thorsten Drautzburg & Harald Uhlig, 2015. "Fiscal Stimulus and Distortionary Taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(4), pages 894-920, October.
    29. John Cogan & John Taylor & Volker Wieland & Maik Wolters, 2013. "Fiscal Consolidation Strategy: An Update for the Budget Reform Proposal of March 2013," Discussion Papers 12-033, Stanford Institute for Economic Policy Research.
    30. Valerie A. Ramey, 2011. "Identifying Government Spending Shocks: It's all in the Timing," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 126(1), pages 1-50.
    31. Vanda Almeida & Gabriela Castro & Ricardo Mourinho Félix & José R. Maria, 2013. "Fiscal Consolidation in a Small Euro-Area Economy," International Journal of Central Banking, International Journal of Central Banking, vol. 9(4), pages 1-38, December.
    32. Mendoza, Enrique G. & Razin, Assaf & Tesar, Linda L., 1994. "Effective tax rates in macroeconomics: Cross-country estimates of tax rates on factor incomes and consumption," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 297-323, December.
    33. Erceg, Christopher J. & Lindé, Jesper, 2013. "Fiscal consolidation in a currency union: Spending cuts vs. tax hikes," Journal of Economic Dynamics and Control, Elsevier, vol. 37(2), pages 422-445.
    34. Jaime Guajardo & Daniel Leigh & Andrea Pescatori, 2014. "Expansionary Austerity? International Evidence," Journal of the European Economic Association, European Economic Association, vol. 12(4), pages 949-968, August.
    35. Edward C. Prescott, 2002. "Prosperity and Depression," American Economic Review, American Economic Association, vol. 92(2), pages 1-15, May.
    36. Baxter, Marianne & King, Robert G, 1993. "Fiscal Policy in General Equilibrium," American Economic Review, American Economic Association, vol. 83(3), pages 315-334, June.
    37. Furlanetto, Francesco, 2011. "Fiscal stimulus and the role of wage rigidity," Journal of Economic Dynamics and Control, Elsevier, vol. 35(4), pages 512-527, April.
    38. Wolters, Maik & Schwarzmüller, Tim, 2014. "The short- and long-run effects of fiscal consolidation in dynamic general equilibrium," VfS Annual Conference 2014 (Hamburg): Evidence-based Economic Policy 100445, Verein für Socialpolitik / German Economic Association.
    39. Trabandt, Mathias & Uhlig, Harald, 2011. "The Laffer curve revisited," Journal of Monetary Economics, Elsevier, vol. 58(4), pages 305-327.
    40. Jeffrey R. Brown, 2010. "Tax Policy and the Economy, Volume 24," NBER Books, National Bureau of Economic Research, Inc, number brow09-1.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Ginters Bušs & Patrick Grüning, 2023. "Fiscal DSGE model for Latvia," Baltic Journal of Economics, Baltic International Centre for Economic Policy Studies, vol. 23(1), pages 2173915-217.
    2. Stelios Sakkas & Petros Varthalitis, 2021. "Public Debt Consolidation and its Distributional Effects," Manchester School, University of Manchester, vol. 89(S1), pages 131-174, September.
    3. Guo, Lingyi & Xu, Wenli & Xu, Kun, 2016. "中国财政政策调整的宏观经济效应——基于消费者异质性的新凯恩斯模型 [The effect of Fiscal Consolidations on Chinese Maroeconomies——Based on The NK Model with Cosummer’s Heterogenicity]," MPRA Paper 69170, University Library of Munich, Germany.
    4. Bletzinger, Tilman & Lalik, Magdalena, 2017. "The impact of constrained monetary policy on fiscal multipliers on output and inflation," Working Paper Series 2019, European Central Bank.
    5. Vybhavi Balasundharam & Olivier Basdevant & Dalmacio Benicio & Andrew Ceber & Yujin Kim & Luca Mazzone & Hoda Selim & Yongzheng Yang, 2023. "Fiscal Consolidation: Taking Stock of Success Factors, Impact, and Design," IMF Working Papers 2023/063, International Monetary Fund.
    6. Sakkas, Stelios & Varthalitis, Petros, 2018. "The (intertemporal) equity-efficiency trade-off of fiscal consolidation," MPRA Paper 90983, University Library of Munich, Germany.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Wolters, Maik & Schwarzmüller, Tim, 2014. "The short- and long-run effects of fiscal consolidation in dynamic general equilibrium," VfS Annual Conference 2014 (Hamburg): Evidence-based Economic Policy 100445, Verein für Socialpolitik / German Economic Association.
    2. Papageorgiou, Dimitris, 2012. "Fiscal policy reforms in general equilibrium: The case of Greece," Journal of Macroeconomics, Elsevier, vol. 34(2), pages 504-522.
    3. Eric M. Leeper & Nora Traum & Todd B. Walker, 2017. "Clearing Up the Fiscal Multiplier Morass," American Economic Review, American Economic Association, vol. 107(8), pages 2409-2454, August.
    4. Bhattarai, Keshab & Trzeciakiewicz, Dawid, 2017. "Macroeconomic impacts of fiscal policy shocks in the UK: A DSGE analysis," Economic Modelling, Elsevier, vol. 61(C), pages 321-338.
    5. Thomas Brand, 2017. "Vitesse et composition des ajustements budgétaires en équilibre général : une analyse appliquée à la zone euro," Revue économique, Presses de Sciences-Po, vol. 68(HS1), pages 159-182.
    6. Ercolani, Valerio & Valle e Azevedo, João, 2014. "The effects of public spending externalities," Journal of Economic Dynamics and Control, Elsevier, vol. 46(C), pages 173-199.
    7. Javier Andrés & José E. Boscá & Javier Ferri, 2016. "Instruments, rules, and household debt: the effects of fiscal policy," Oxford Economic Papers, Oxford University Press, vol. 68(2), pages 419-443.
    8. Reicher, Claire, 2014. "Systematic fiscal policy and macroeconomic performance: A critical overview of the literature," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 8, pages 1-37.
    9. Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2017. "Fiscal Consolidation in an Open Economy with Sovereign Premia and without Monetary Policy Independence," International Journal of Central Banking, International Journal of Central Banking, vol. 13(4), pages 259-306, December.
    10. Eric Sims & Jonathan Wolff, 2018. "The Output And Welfare Effects Of Government Spending Shocks Over The Business Cycle," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 59(3), pages 1403-1435, August.
    11. George Economides & Dimitris Papageorgiou & Apostolis Philippopoulos, 2017. "The driving forces of the current Greek great depression," Working Papers 201703, Athens University Of Economics and Business, Department of Economics.
    12. Banerjee, Ryan & Zampolli, Fabrizio, 2019. "What drives the short-run costs of fiscal consolidation? Evidence from OECD countries," Economic Modelling, Elsevier, vol. 82(C), pages 420-436.
    13. Javier Andres & Oscar Arce & Dominik Thaler & Carlos Thomas, 2020. "When Fiscal Consolidation Meets Private Deleveraging," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 37, pages 214-233, July.
    14. Richard McManus & F. Gulcin Ozkan & Dawid Trzeciakiewicz, 2014. "Who is afraid of austerity? The redistributive impact of fiscal policy in a DSGE framework," Discussion Papers 14/22, Department of Economics, University of York.
    15. Philippopoulos, Apostolis & Varthalitis, Petros & Vassilatos, Vanghelis, 2017. "Fiscal consolidation and its cross-country effects," Journal of Economic Dynamics and Control, Elsevier, vol. 83(C), pages 55-106.
    16. Emi Nakamura & J?n Steinsson, 2014. "Fiscal Stimulus in a Monetary Union: Evidence from US Regions," American Economic Review, American Economic Association, vol. 104(3), pages 753-792, March.
    17. Lorant Kaszab, 2016. "Rule-of-Thumb Consumers and Labor Tax Cut Policy at the Zero Lower Bound," International Journal of Central Banking, International Journal of Central Banking, vol. 12(3), pages 353-390, September.
    18. Moura, Guilherme Valle, 2015. "Multiplicadores Fiscais e Investimento em Infraestrutura," Revista Brasileira de Economia - RBE, EPGE Brazilian School of Economics and Finance - FGV EPGE (Brazil), vol. 69(1), March.
    19. Stelios Sakkas & Petros Varthalitis, 2021. "Public Debt Consolidation and its Distributional Effects," Manchester School, University of Manchester, vol. 89(S1), pages 131-174, September.
    20. Eric M. Leeper & Nora Traum & Todd B. Walker, 2015. "Clearing Up the Fiscal Multiplier Morass: Prior and Posterior Analysis," NBER Working Papers 21433, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    fiscal consolidation; government debt; distortionary taxes; zero lower bound; welfare; monetary-fiscal policy interaction;
    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
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • H61 - Public Economics - - National Budget, Deficit, and Debt - - - Budget; Budget Systems
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:zbw:ifwkwp:1963. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ZBW - Leibniz Information Centre for Economics (email available below). General contact details of provider: https://edirc.repec.org/data/iwkiede.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.