Scandinavian Working Papers in Economics
Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)
No 322: Fiscal Consolidation Under Imperfect Credibility
Matthieu Lemoine () and Jesper Lindé ()
Additional contact information
Matthieu Lemoine: Unit of forecasting and macroeconomic studies, Postal: Banque de France, 31 rue Croix des petits champs, 75001 PARIS, France
Jesper Lindé: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Abstract: This paper examines the effects of expenditure-based fiscal consolidation when credibility as to whether the cuts will be long-lasting is imperfect. We contrast the impact limited credibility has when the consolidating country has the means to tailor mon- etary policy to its own needs, with the impact when the country is a small member of a currency union with a negligible effect on interest rates and on nominal exchange rates of the currency union. We find two key results. First, in the case of an independ- ent monetary policy, the adverse impact of limited credibility is relatively small, and consolidation can be expected to reduce government debt at a relatively low output cost given that monetary policy provides more accommodation than it would under perfect credibility. Second, the lack of monetary accommodation under currency union membership implies that the output cost may be significantly larger, and that progress in reducing government debt in the short and medium term may be limited under imperfect credibility.
Keywords: Monetary and Fiscal Policy; Front-Loaded vs. Gradual Consolidation; DSGE Model; Sticky Prices and Wages; Currency Union
75 pages, May 1, 2016
Full text files
rap_wp322_160512.pdf
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