Date Added: Jul 2011
The authors develop a new-Keynesian DSGE model with an extended fiscal policy block to assess the conditions for expansionary fiscal consolidations. In addition to several taxes, they consider public employment expenditures and government spending, which may have different degrees of productivity. They calibrate the model for the Euro Area and use it to simulate alternative fiscal consolidations with changes in the budget composition. Among the main conclusions they find that: if conducted with a cut in weakly-productive spending and a symmetric increase in highly-productive spending, fiscal consolidations have expansionary effects on investment and output; if consolidation is pursued through a pure reduction in weakly-productive public employment, the effects on output decrease with the degree of labor market competition and turn out to be positive under perfect competition.