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To react or not? Technology shocks, fiscal policy and welfare in the EU-3


Malley, Jim; Philippopoulos, Apostolis; Woitek, Ulrich (2009). To react or not? Technology shocks, fiscal policy and welfare in the EU-3. European Economic Review, 53(6):689-714.

Abstract

This paper develops a DSGE model to examine the quantitative macroeconomic implications of counter-cyclical fiscal policy for France, Germany and the UK. The model incorporates real wage rigidity and consumption habits, as the particular market failures justifying policy intervention. We subject the model to productivity shocks and allow policy instruments to react to the output gap and the debt-to-output ratio. A welfare analysis reveals that the most effective instrument-target combination is to use public consumption to stabilize the output gap. Moreover, welfare gains from counter-cyclical fiscal policy are much stronger in the presence of wage rigidities compared with consumption habits. Finally, since active policy and automatic stabilizers are substitutes, it is possible that relatively undistorted economies may be in need of countercyclical fiscal action due to inadequate automatic stabilizers.

Abstract

This paper develops a DSGE model to examine the quantitative macroeconomic implications of counter-cyclical fiscal policy for France, Germany and the UK. The model incorporates real wage rigidity and consumption habits, as the particular market failures justifying policy intervention. We subject the model to productivity shocks and allow policy instruments to react to the output gap and the debt-to-output ratio. A welfare analysis reveals that the most effective instrument-target combination is to use public consumption to stabilize the output gap. Moreover, welfare gains from counter-cyclical fiscal policy are much stronger in the presence of wage rigidities compared with consumption habits. Finally, since active policy and automatic stabilizers are substitutes, it is possible that relatively undistorted economies may be in need of countercyclical fiscal action due to inadequate automatic stabilizers.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Economics
06 Faculty of Arts > Institute of History
Dewey Decimal Classification:900 History
330 Economics
Language:English
Date:2009
Deposited On:07 Jan 2010 14:16
Last Modified:05 Apr 2016 13:43
Publisher:Elsevier
ISSN:0014-2921
Publisher DOI:https://doi.org/10.1016/j.euroecorev.2009.01.005

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