Applied Seminar

Concepción González García

Universidad de Alicante


Seminar 3 – 14:30


In this paper, we build a general equilibrium model to study the macroeconomics effects of alternative fiscal consolidation strategies when the private sector is heavily indebted. We model fiscal consolidation as a permanent decrease in the targeted debt-to-GDP ratio by means of government spending cuts or tax hikes. Our analysis shows that in the short-run, fiscal policies that raise labour or capital tax rates induce deleveraging in the private sector, which amplifies temporary output losses due to fiscal consolidation. By contrast, fiscal consolidation achieved by government spending cuts or consumption tax hikes ease private debt repayment, thereby mitigating the negative output effect. In the long run, we find that fiscal consolidation entails output benefits that are dampened when private debt is high. This effect occurs independently of the fiscal rule used to stabilize debt and is especially important when distortionary taxation is used. Finally, we find that a fiscal consolidation produces a social welfare gain when government spending and consumption tax rates adjust

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