Day of Reckoning: Output Losses from Fiscal Stabilizations

66 Pages Posted: 16 Nov 2018

See all articles by Domenico Ferraro

Domenico Ferraro

Arizona State University (ASU) - Economics Department

Pietro F. Peretto

Duke University - Department of Economics; Duke Innovation & Entrepreneurship Initiative

Date Written: September 27, 2018

Abstract

We derive the quantitative implications of reducing sustained budget deficits (labeled fiscal stabilizations) in the context of a general equilibrium model of innovation-led growth. In the model, innovation comes from entrant firms creating new products and incumbent firms improving own existing products. We discipline parameters using post-war observations for the U.S. economy. We find that fiscal stabilizations achieved via labor tax rate hikes permanently lower the equilibrium path of aggregate output. Output losses are sizable. For example, stabilizing the government debt-to-GDP ratio after 10 consecutive years of approximately 5% deficit-to-GDP ratios, entails a nearly 2% permanent loss in income per capita.

Keywords: Government debt; Budget deficits; Government spending; Taxes; Growth; Firms’ entry; Innovation

JEL Classification: E23; E24; E62; O30; O40

Suggested Citation

Ferraro, Domenico and Peretto, Pietro F., Day of Reckoning: Output Losses from Fiscal Stabilizations (September 27, 2018). Economic Research Initiatives at Duke (ERID) Working Paper No. 278, Available at SSRN: https://ssrn.com/abstract=3284769 or http://dx.doi.org/10.2139/ssrn.3284769

Domenico Ferraro

Arizona State University (ASU) - Economics Department ( email )

Tempe, AZ 85287-3806
United States

Pietro F. Peretto (Contact Author)

Duke University - Department of Economics ( email )

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
United States
919-660-1807 (Phone)
919-684-8974 (Fax)

Duke Innovation & Entrepreneurship Initiative ( email )

215 Morris St., Suite 300
Durham, NC 27701
United States

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