Fiscal Compact and Debt Consolidation Dynamics

40 Pages Posted: 13 Jun 2018 Last revised: 7 Nov 2018

See all articles by Luca Brugnolini

Luca Brugnolini

Rokos Capital Management

Luisa Corrado

University of Rome Tor Vergata Department of Economics and Finance

Date Written: June 8, 2018

Abstract

We analyse the macroeconomic effects of a debt consolidation policy in the Euro Area mimicking the Fiscal Compact Rule (FCR). The rule requires the signatory states to target a debt-to-GDP ratio below 60%. Within the context of Dynamic Stochastic General Equilibrium models (DSGE), we augment a fully micro-founded New-Keynesian model with a parametric linear debt consolidation rule, and we analyse the effects on the main macroeconomic aggregates. To fully understand its implications on the economy, we study different debt consolidation scenarios, allowing the excess debt to be re-absorbed with different timings. We show that including a debt consolidation rule can exacerbate the effects of the shocks in the economy by imposing a constraint on the public debt process. Secondly, we note that the effect of loosening or tightening the rule in response to a shock is heterogeneous. Shocks hitting nominal variables (monetary policy shock) are not particularly sensitive. On the contrary, we prove that the same change has a more pronounced effect in case of shock hitting real variables (productivity and public spending shocks). Finally, we show that the macroeconomic framework worsens as a function of the rigidity of the debt consolidation rule. As a limiting case, we show that the effects on output, employment, real wages, inflation, and interest rates are sizable.

Keywords: fi scal policy, debt consolidation, government spending, New-Keynesian, DSGE

JEL Classification: E10, E30, E62

Suggested Citation

Brugnolini, Luca and Corrado, Luisa, Fiscal Compact and Debt Consolidation Dynamics (June 8, 2018). CEIS Working Paper No. 436. Available at SSRN: https://ssrn.com/abstract=3192941 or http://dx.doi.org/10.2139/ssrn.3192941

Luca Brugnolini (Contact Author)

Rokos Capital Management ( email )

London
United Kingdom

Luisa Corrado

University of Rome Tor Vergata Department of Economics and Finance ( email )

Via Columbia n.2
Rome, rome 00100
Italy

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