To react or not? Technology shocks, fiscal policy and welfare in the EU-3

Malley, J. , Philippopoulos, A. and Woitek, U. (2009) To react or not? Technology shocks, fiscal policy and welfare in the EU-3. European Economic Review, 53(6), pp. 689-714. (doi: 10.1016/j.euroecorev.2009.01.005)

Abstract

This paper develops a dynamic stochastic general equilibrium (DSGE) model to examine the quantitative macroeconomic implications of counter-cyclical fiscal policy for France, Germany and the UK. The model incorporates real wage rigidity and consumption habits, as the particular market failures justifying policy intervention. We subject the model to productivity shocks and allow policy instruments to react to the output gap and the debt-to-output ratio. A welfare analysis reveals that the most effective instrument-target combination is to use public consumption to stabilize the output gap. Moreover, welfare gains from counter-cyclical fiscal policy are much stronger in the presence of wage rigidities compared with consumption habits. Finally, since active policy and automatic stabilizers are substitutes, it is possible that relatively undistorted economies may be in need of countercyclical fiscal action due to inadequate automatic stabilizers.

• Item Type: Articles
• Additional Information: Special Section: European Economic Surveys
• Status: Published
• Refereed: Yes
• Glasgow Author(s) Enlighten ID: Woitek, Prof Ulrich and Philippopoulos, Prof Apostolis and Malley, Professor Jim
• Authors: Malley, J., Philippopoulos, A., and Woitek, U.
• Subjects: H Social Sciences > HB Economic Theory
• College/School: College of Social Sciences > Adam Smith Business School > Economics
• Journal Name: European Economic Review
• ISSN: 0014-2921
• Published Online: 19 March 2009