Working Paper
Fiscal consolidation in a currency union: spending cuts vs. tax hikes
Abstract: This paper uses a two country DSGE model to examine the effects of tax-based versus expenditure-based fiscal consolidation in a currency union. We find three key results. First, given limited scope for monetary accommodation, tax-based consolidation tends to have smaller adverse effects on output than expenditure-based consolidation in the near-term, though is more costly in the longer-run. Second, a large expenditure-based consolidation may be counterproductive in the near-term if the zero lower bound is binding, reflecting that output losses rise at the margin. Third, a \"mixed strategy\" that combines a sharp but temporary rise in taxes with gradual spending cuts may be desirable in minimizing the output costs of fiscal consolidation.
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Bibliographic Information
Provider: Board of Governors of the Federal Reserve System (U.S.)
Part of Series: International Finance Discussion Papers
Publication Date: 2012
Number: 1063