IDEAS home Printed from https://ideas.repec.org/p/zbw/vfsc14/100445.html
   My bibliography  Save this paper

The short- and long-run effects of fiscal consolidation in dynamic general equilibrium

Author

Listed:
  • Wolters, Maik
  • Schwarzmüller, Tim

Abstract

We provide a systematic analysis of fiscal consolidation in a dynamic general equilibrium model with a detailed government sector and a share of credit-constrained households. We simulate permanent cuts in government consumption, government investment, and transfer payments as well as permanent increases in the labor, capital and consumption tax rate. We find that ordering these consolidation strategies by multiplier size or their welfare consequences leads to very different rankings. With respect to welfare gains cuts in government consumption rank highest because they yield the largest increase in private consumption in the short- and long-run. This however comes at the cost of large temporary reductions in output. Cutting transfers has the largest positive effects on output, yet the welfare consequences rank lowest since labor input does not decrease so that there is no increase in leisure. Cuts in government investment and capital tax increases have detrimental effects on output in the short- and long-run. From a welfare perspective they do not rank lowest because the slow convergence of the system to the final steady state leads to substantial discounting of the implied long-run drop in consumption. To explain these different outcomes we analyze the short- and long-run transmission channels of the different consolidation instruments. Furthermore, we study how the transmission of fiscal consolidation changes in the case of a binding zero lower bound on nominal interest rates.

Suggested Citation

  • Wolters, Maik & Schwarzmüller, Tim, 2014. "The short- and long-run effects of fiscal consolidation in dynamic general equilibrium," VfS Annual Conference 2014 (Hamburg): Evidence-based Economic Policy 100445, Verein für Socialpolitik / German Economic Association.
    • Handle: RePEc:zbw:vfsc14:100445
    as

    Download full text from publisher

    File URL: https://www.econstor.eu/bitstream/10419/100445/1/VfS_2014_pid_221.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Thorsten Drautzburg & Harald Uhlig, 2015. "Fiscal Stimulus and Distortionary Taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(4), pages 894-920, October.
    2. Edward C. Prescott, 2004. "Why do Americans work so much more than Europeans?," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 28(Jul), pages 2-13.
    3. Mendoza, Enrique G. & Razin, Assaf & Tesar, Linda L., 1994. "Effective tax rates in macroeconomics: Cross-country estimates of tax rates on factor incomes and consumption," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 297-323, December.
    4. Thorsten Drautzburg & Harald Uhlig, 2015. "Fiscal Stimulus and Distortionary Taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(4), pages 894-920, October.
    5. Cogan, John F. & Cwik, Tobias & Taylor, John B. & Wieland, Volker, 2010. "New Keynesian versus old Keynesian government spending multipliers," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 281-295, March.
    6. Edward C. Prescott, 2002. "Prosperity and Depression: 2002 Richard T. Ely Lecture," Working Papers 618, Federal Reserve Bank of Minneapolis.
    7. Erceg, Christopher J. & Lindé, Jesper, 2013. "Fiscal consolidation in a currency union: Spending cuts vs. tax hikes," Journal of Economic Dynamics and Control, Elsevier, vol. 37(2), pages 422-445.
    8. Lawrence Christiano & Martin Eichenbaum & Sergio Rebelo, 2011. "When Is the Government Spending Multiplier Large?," Journal of Political Economy, University of Chicago Press, vol. 119(1), pages 78-121.
    9. Coenen, Günter & Mohr, Matthias & Straub, Roland, 2008. "Fiscal consolidation in the euro area: Long-run benefits and short-run costs," Economic Modelling, Elsevier, vol. 25(5), pages 912-932, September.
    10. Cogan, John F. & Taylor, John B. & Wieland, Volker & Wolters, Maik H., 2013. "Fiscal consolidation strategy," Journal of Economic Dynamics and Control, Elsevier, vol. 37(2), pages 404-421.
    11. Günter Coenen & Christopher J. Erceg & Charles Freedman & Davide Furceri & Michael Kumhof & René Lalonde & Douglas Laxton & Jesper Lindé & Annabelle Mourougane & Dirk Muir & Susanna Mursula & Carlos d, 2012. "Effects of Fiscal Stimulus in Structural Models," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(1), pages 22-68, January.
    12. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
    13. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    14. Edward C. Prescott, 2002. "Prosperity and Depression," American Economic Review, American Economic Association, vol. 92(2), pages 1-15, May.
    15. Baxter, Marianne & King, Robert G, 1993. "Fiscal Policy in General Equilibrium," American Economic Review, American Economic Association, vol. 83(3), pages 315-334, June.
    16. Raj Chetty & Adam Guren & Day Manoli & Andrea Weber, 2011. "Are Micro and Macro Labor Supply Elasticities Consistent? A Review of Evidence on the Intensive and Extensive Margins," American Economic Review, American Economic Association, vol. 101(3), pages 471-475, May.
    17. Forni, Lorenzo & Gerali, Andrea & Pisani, Massimiliano, 2010. "The macroeconomics of fiscal consolidations in euro area countries," Journal of Economic Dynamics and Control, Elsevier, vol. 34(9), pages 1791-1812, September.
    18. Thorsten Drautzburg & Harald Uhlig, 2015. "Fiscal Stimulus and Distortionary Taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(4), pages 894-920, October.
    19. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Stelios Sakkas & Petros Varthalitis, 2021. "Public Debt Consolidation and its Distributional Effects," Manchester School, University of Manchester, vol. 89(S1), pages 131-174, September.
    2. Schwarzmüller, Tim & Wolters, Maik H., 2014. "The macroeconomic effects of fiscal consolidation in dynamic general equilibrium," Kiel Working Papers 1963, Kiel Institute for the World Economy (IfW Kiel).
    3. Vybhavi Balasundharam & Olivier Basdevant & Dalmacio Benicio & Andrew Ceber & Yujin Kim & Luca Mazzone & Hoda Selim & Yongzheng Yang, 2023. "Fiscal Consolidation: Taking Stock of Success Factors, Impact, and Design," IMF Working Papers 2023/063, International Monetary Fund.
    4. Moura, Guilherme Valle, 2015. "Multiplicadores Fiscais e Investimento em Infraestrutura," Revista Brasileira de Economia - RBE, EPGE Brazilian School of Economics and Finance - FGV EPGE (Brazil), vol. 69(1), March.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Schwarzmüller, Tim & Wolters, Maik H., 2014. "The macroeconomic effects of fiscal consolidation in dynamic general equilibrium," Kiel Working Papers 1963, Kiel Institute for the World Economy (IfW Kiel).
    2. Eric M. Leeper & Nora Traum & Todd B. Walker, 2017. "Clearing Up the Fiscal Multiplier Morass," American Economic Review, American Economic Association, vol. 107(8), pages 2409-2454, August.
    3. Thomas Brand, 2017. "Vitesse et composition des ajustements budgétaires en équilibre général : une analyse appliquée à la zone euro," Revue économique, Presses de Sciences-Po, vol. 68(HS1), pages 159-182.
    4. Eric Sims & Jonathan Wolff, 2018. "The Output And Welfare Effects Of Government Spending Shocks Over The Business Cycle," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 59(3), pages 1403-1435, August.
    5. Bhattarai, Keshab & Trzeciakiewicz, Dawid, 2017. "Macroeconomic impacts of fiscal policy shocks in the UK: A DSGE analysis," Economic Modelling, Elsevier, vol. 61(C), pages 321-338.
    6. Lorant Kaszab, 2016. "Rule-of-Thumb Consumers and Labor Tax Cut Policy at the Zero Lower Bound," International Journal of Central Banking, International Journal of Central Banking, vol. 12(3), pages 353-390, September.
    7. Yasuharu Iwata, 2011. "The Government Spending Multiplier and Fiscal Financing: Insights from Japan," International Finance, Wiley Blackwell, vol. 14(2), pages 231-264, June.
    8. Papageorgiou, Dimitris, 2012. "Fiscal policy reforms in general equilibrium: The case of Greece," Journal of Macroeconomics, Elsevier, vol. 34(2), pages 504-522.
    9. Coenen, Günter & Straub, Roland & Trabandt, Mathias, 2013. "Gauging the effects of fiscal stimulus packages in the euro area," Journal of Economic Dynamics and Control, Elsevier, vol. 37(2), pages 367-386.
    10. Stähler, Nikolai & Thomas, Carlos, 2012. "FiMod — A DSGE model for fiscal policy simulations," Economic Modelling, Elsevier, vol. 29(2), pages 239-261.
    11. Richard McManus & F. Gulcin Ozkan & Dawid Trzeciakiewicz, 2014. "Who is afraid of austerity? The redistributive impact of fiscal policy in a DSGE framework," Discussion Papers 14/22, Department of Economics, University of York.
    12. Cloyne, James S, 2011. "Government spending shocks, wealth effects and distortionary taxes," MPRA Paper 41689, University Library of Munich, Germany.
    13. Cogan, John F. & Taylor, John B. & Wieland, Volker & Wolters, Maik H., 2013. "Fiscal consolidation strategy," Journal of Economic Dynamics and Control, Elsevier, vol. 37(2), pages 404-421.
    14. Javier Andrés & José E. Boscá & Javier Ferri, 2016. "Instruments, rules, and household debt: the effects of fiscal policy," Oxford Economic Papers, Oxford University Press, vol. 68(2), pages 419-443.
    15. Emi Nakamura & J?n Steinsson, 2014. "Fiscal Stimulus in a Monetary Union: Evidence from US Regions," American Economic Review, American Economic Association, vol. 104(3), pages 753-792, March.
    16. Reicher, Claire, 2014. "Systematic fiscal policy and macroeconomic performance: A critical overview of the literature," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 8, pages 1-37.
    17. Gomes, S. & Jacquinot, P. & Mestre, R. & Sousa, J., 2015. "Global policy at the zero lower bound in a large-scale DSGE model," Journal of International Money and Finance, Elsevier, vol. 50(C), pages 134-153.
    18. Lemoine, Matthieu & Lindé, Jesper, 2023. "Fiscal stimulus in liquidity traps: Conventional or unconventional policies?," European Economic Review, Elsevier, vol. 151(C).
    19. Ercolani, Valerio & Valle e Azevedo, João, 2014. "The effects of public spending externalities," Journal of Economic Dynamics and Control, Elsevier, vol. 46(C), pages 173-199.
    20. Lemoine, Matthieu & Lindé, Jesper, 2016. "Fiscal consolidation under imperfect credibility," European Economic Review, Elsevier, vol. 88(C), pages 108-141.

    More about this item

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • H61 - Public Economics - - National Budget, Deficit, and Debt - - - Budget; Budget Systems

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:zbw:vfsc14:100445. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ZBW - Leibniz Information Centre for Economics (email available below). General contact details of provider: https://edirc.repec.org/data/vfsocea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.