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FISCAL AUSTERITY MEASURES: SPENDING CUTS VS. TAX INCREASES

Published online by Cambridge University Press:  01 March 2018

Gerhard Glomm,
Juergen Jung and
Chung Tran
Gerhard Glomm*
Affiliation:
Indiana University
Juergen Jung
Affiliation:
Towson University
Chung Tran
Affiliation:
Australian National University
*
Address correspondence to: Gerhard Glomm, Department of Economics, Indiana University–Bloomington, Bloomington, IN 47405, USA; e-mail: gglomm@indiana.edu.
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Abstract

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We formulate an overlapping-generations model with household heterogeneity and productive and nonproductive government programs to study the macroeconomic and intergenerational welfare effects of risk premium shocks and government debt reductions. We demonstrate that in a small open economy with a high level of debt, a small increase in the risk premium of the interest rate leads to a substantial contraction in output and negative welfare effects. We then quantify the effects of reducing the debt-to-gross-domestic-product ratio using a wide range of fiscal austerity measures. Our results indicate trade-offs between short-run contractions and long-run expansions in aggregate output. In the short run, spending-based austerity reforms are worse than tax-based reforms in terms of lost income. However, in the long run, spending-based reforms produce higher output than tax-based reforms. In addition, welfare effects vary significantly across generations, skill groups, and working sectors. The current old and middle-aged generations experience welfare losses, whereas future generations are beneficiaries of the reforms.

Keywords

Fiscal ConsolidationWelfareDistributional EffectsOverlapping GenerationsDynamic General Equilibrium

Information

Type
Articles
Information
Macroeconomic Dynamics , Volume 22 , Issue 2 , March 2018, pp. 501 - 540
Copyright
Copyright © Cambridge University Press 2018 

Footnotes

We appreciate comments from participants in the Australasian Macroeconomics Workshop 2012, the Midwest Macroeconomics Meeting 2012, and the 18th International Conference of Computing in Economics and Finance 2012, and from two anonymous referees. The authors acknowledge supports from the Towson University Research Fellowship Program and from an ANU Research Grant. The usual disclaimers apply.

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