Fiscal Consolidation in the Euro Area: Long-Run Benefits and Short-Run Costs

48 Pages Posted: 14 May 2008

See all articles by Günter Coenen

Günter Coenen

European Central Bank (ECB)

Matthias F. Mohr

European Central Bank (ECB)

Roland Straub

European Central Bank (ECB)

Date Written: May 1, 2008

Abstract

In this paper, we examine the macroeconomic effects of alternative fiscal consolidation policies in the New Area-Wide Model (NAWM), a two-country open-economy model of the euro area developed at the European Central Bank (cf. Coenen et al., 2007). We model fiscal consolidation as a permanent reduction in the targeted government debt-to-output ratio and analyse both expenditure and revenue-based policies that are implemented by means of simple fiscal feedback rules. We find that fiscal consolidation has positive long-run effects on key macroeconomic aggregates such as output and consumption, notably when the resulting improvement in the budgetary position is used to lower distortionary taxes. At the same time, fiscal consolidation gives rise to noticeable short-run adjustment costs in contrast to what the literature on expansionary fiscal consolidations suggests. Moreover, depending on the fiscal instrument used, fiscal consolidation may have pronounced distributional effects.

Keywords: DSGE modelling, limited asset-market participation, fiscal policy, fiscal consolidation, euro area

JEL Classification: E32, E62

Suggested Citation

Coenen, Günter and Mohr, Matthias F. and Straub, Roland, Fiscal Consolidation in the Euro Area: Long-Run Benefits and Short-Run Costs (May 1, 2008). ECB Working Paper No. 902, Available at SSRN: https://ssrn.com/abstract=1126657 or http://dx.doi.org/10.2139/ssrn.1126657

Günter Coenen (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 7887 (Phone)
+49 69 1344 6575 (Fax)

Matthias F. Mohr

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Roland Straub

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
107
Abstract Views
1,373
Rank
470,481
PlumX Metrics