When is fiscal consolidation optimal
In this paper, Le Grand and Ragot analyze optimal fiscal policy in a heterogeneous-agent model with capital accumulation, incomplete markets, borrowing constraints, and aggregate shocks. The authors consider various fiscal instruments like capital taxes, labor taxes (level and progressivity), and public debt. Their key results are:
- For utility functions exhibiting decreasing relative risk aversion, the optimal steady-state features positive capital taxes to improve consumption smoothing across employed and unemployed agents.
- For the standard CRRA utility function, the optimal steady-state capital tax is zero. However, with a non-utilitarian social welfare function that places lower weight on unemployed agents, positive capital taxes can be optimal even with CRRA preferences.
- The dynamics of optimal public debt crucially depend on the persistence of the public spending shock. For low persistence shocks, public debt increases to facilitate consumption smoothing. For high persistence shocks, public debt decreases as the planner front-loads the fiscal adjustment.
- In the quantitative heterogeneous-agent model calibrated to the U.S., both capital and labor taxes increase after a spending shock, but more so when the shock is transitory. Public debt exhibits persistent deviations, increasing for transitory shocks but decreasing for persistent shocks.
Optimal Fiscal Policy With Heterogeneous Agents and Capital: Should We Increase or Decrease Public Debt and Capital Taxes?
Authors: François Le Grand, Xavier Ragot
From: Rennes School of Business, Sciences Po
Fiscal consolidation optimal: the case of Spain
Alloza et al. in this paper present a methodology for analyzing public debt sustainability in Spain that incorporates stochastic shocks to capture uncertainty in the macro-financial environment. The key findings are:
- In a no-fiscal-consolidation scenario, there is an 80% probability that Spain’s public debt will exceed 100% of GDP in 2040, driven by the deterioration in the primary balance due to aging costs.
- If the automatic adjustment mechanism in the 2023 pension reform is activated, raising social security contributions, the probability of debt exceeding 100% of GDP in 2040 decreases to 72%.
- Under a fiscal consolidation scenario aligned with the new European economic governance framework, the probability of debt exceeding 100% of GDP in 2040 drops to 20%, while the probability of it being below 60% turns positive.
- Combining fiscal consolidation with structural reforms that raise potential GDP growth to 1.9% would further reduce the probability of debt exceeding 100% of GDP in 2040 to 11%.
- The stochastic analysis shows that fiscal consolidation not only reduces the debt ratio but also concentrates its distribution around lower values, mitigating the impact of macro-financial uncertainty.
Public debt dynamics: a stochastic approach applied to Spain
Authors: Mario Alloza, Jorge Martínez, Juan Rojas, Iacopo Varotto
From: Banco de España
