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Fiscal stabilization in high-debt economies without monetary independence

Author

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  • Germaschewski, Yin
  • Wang, Shu-Ling
Abstract
Fiscal stabilization without monetary autonomy can be challenging, especially in high-debt economies. This paper studies the welfare outcomes of six fiscal stabilization rules in Greece, a highly indebted country in a monetary union. We introduce rich fiscal policy instruments into a small open economy dynamic stochastic general equilibrium model and estimate it using Bayesian methods. Four results emerge. First, the estimated fiscal policy rules show a lack of fiscal stabilization, which contributes to rising public debt. Second, productive spending-based policy rules dominate the tax-based rules in welfare terms. Welfare gains are mainly driven by agents’ expectations of the future fiscal policy stance. Third, the optimal stabilization policy features a simultaneous adjustment of all spending and taxes. In the case of negative productivity shocks, the optimal response is to expand public consumption and employment, raise the labor tax rate, and reduce public investment and tax rates on consumption and capital. Fourth, sizable distributional effects are found across savers and hand-to-mouth households, with savers’ welfare gains being quantitatively greater than those of hand-to-mouth agents.

Suggested Citation

  • Germaschewski, Yin & Wang, Shu-Ling, 2022. "Fiscal stabilization in high-debt economies without monetary independence," Journal of Macroeconomics, Elsevier, vol. 72(C).
    • Handle: RePEc:eee:jmacro:v:72:y:2022:i:c:s0164070422000027
    DOI: 10.1016/j.jmacro.2022.103398
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    More about this item

    Keywords

    Fiscal stabilization policy; Welfare; Monetary independence; High-debt economies;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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