Debt Consolidation and Fiscal Stabilization of Deep Recessions

14 Pages Posted: 8 Feb 2010

See all articles by Giancarlo Corsetti

Giancarlo Corsetti

University of Cambridge; University of Rome III - Department of Economics; Centre for Economic Policy Research (CEPR)

Keith Kuester

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Andre Meier

International Monetary Fund (IMF)

Gernot J. Müller

University of Tuebingen - Department of Economics

Date Written: January 2010

Abstract

The global financial crisis of 2008-09 has sent public debt on sharply higher trajectories. With the economic recovery gradually taking hold, the focus is now shifting to fiscal "exit" strategies. Medium-term consolidation efforts are likely to include not only tax increases but also sizeable spending cuts. Our paper uses a standard new Keynesian model to show that the anticipation of such medium-term spending cuts generally enhances the expansionary effect of short-run fiscal stimulus. This conclusion still applies when monetary policy is constrained by the zero lower bound on policy rates. In this case, however, the reversal of government spending must not occur too early on the recovery path, or at least must be suitably gradual.

Keywords: consolidation, exit strategy, fiscal multiplier, Fiscal policy, fiscal stabilization, monetary policy, zero lower bound

JEL Classification: E52, E62, E63

Suggested Citation

Corsetti, Giancarlo and Kuester, Keith and Meier, Andre and Müller, Gernot J., Debt Consolidation and Fiscal Stabilization of Deep Recessions (January 2010). CEPR Discussion Paper No. DP7649, Available at SSRN: https://ssrn.com/abstract=1547569

Giancarlo Corsetti (Contact Author)

University of Cambridge ( email )

University of Rome III - Department of Economics ( email )

via Ostiense 139
Rome, 00154
Italy
+39 06 5737 4056 (Phone)
+39 06 5737 4093 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Keith Kuester

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Andre Meier

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Gernot J. Müller

University of Tuebingen - Department of Economics ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

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