Fiscal consolidation in an open economy with sovereign premia and without monetary policy independence

December 7, 2017 | Journal Article

Authors: Apostolis Philippopoulos , Petros Varthalitis , Vanghelis Vassilatos
International Journal of Central Banking , Vol. 13, No. 4, December 2017

We welfare rank various tax-spending-debt policies in a New Keynesian model of a small open economy featuring sovereign interest rate premia and loss of monetary policy independence. When we compute optimized state-contingent policy rules, our results are as follows: (i) Debt consolidation comes at a short-term pain, but the medium- and long-term gains can be substantial. (ii) In the early phase of pain, the best fiscal policy mix is to cut public consumption spending to address the debt problem and, at the same time, to cut income tax rates to mitigate the recessionary effects of debt consolidation. (iii) In the long run, the best way of using the fiscal space created is to reduce capital taxes.

  • Publication Details

    Journal Article

    ESRI Series Number: 201750
    Research Area: Macroeconomics
    Date of Publication: December 7, 2017
    Published Online: December 07, 2017
    Publisher: The Association of the International Journal of Central Banking
    View External Link

© 2015 The Economic and Social Research Institute. All rights reserved. Website by JET Design