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

December 7, 2017

International Journal of Central Banking, Vol. 13, No. 4, December 2017

External Link

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.

Author(s)
Apostolis Philippopoulos
Vanghelis Vassilatos
Research Area(s)

Publication Details

Publisher

The Association of the International Journal of Central Banking

Date of Publication

December 7, 2017

Journal Article Online Date

December 7, 2017

ESRI Series

Journal Article