Fiscal consolidation and its cross-country effects

Philippopoulos, A., Varthalitis, P. and Vassilatos, V. (2017) Fiscal consolidation and its cross-country effects. Journal of Economic Dynamics and Control, 83, pp. 55-106. (doi:10.1016/j.jedc.2017.07.007)

Philippopoulos, A., Varthalitis, P. and Vassilatos, V. (2017) Fiscal consolidation and its cross-country effects. Journal of Economic Dynamics and Control, 83, pp. 55-106. (doi:10.1016/j.jedc.2017.07.007)

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Abstract

We build a new Keynesian DSGE model consisting of two heterogeneous countries in a monetary union. We study how public debt consolidation in a country with high debt (like Italy) affects welfare in a country with solid public finances (like Germany). Our results show that debt consolidation in the high-debt country benefits the country with solid public finances over all time horizons, while, in Italy, debt consolidation is productive in the medium and long term. All this is with optimized feedback policy rules. On the other hand, fiscal consolidation hurts both countries and all the time, if it is implemented in an ad hoc way, like an increase in taxes. The least distorting fiscal mix from the point of view of both countries is the one which, during the early phase of pain, Italy cuts public consumption spending to address its debt problem and, at the same time, reduces income tax rates, while, once its debt has been reduced in the later phase, it uses the fiscal space to further cut income taxes.

Item Type:Articles
Status:Published
Refereed:Yes
Glasgow Author(s) Enlighten ID:Philippopoulos, Prof Apostolis and Varthalitis, Dr Petros
Authors: Philippopoulos, A., Varthalitis, P., and Vassilatos, V.
College/School:College of Social Sciences > Adam Smith Business School > Economics
Journal Name:Journal of Economic Dynamics and Control
Publisher:Elsevier
ISSN:0165-1889
ISSN (Online):1879-1743
Published Online:02 August 2017
Copyright Holders:Copyright © 2017 Elsevier B.V.
First Published:First published in Journal of Economic Dynamics and Control 83:55-106
Publisher Policy:Reproduced in accordance with the publisher copyright policy

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