Series: Working Papers. 1622.
Author: Javier Andrés, Óscar Arce and Carlos Thomas.
Topics: Economic and Monetary Union | Monetary policy | Transmission of monetary policy | Labour market | Banco de España.
Published in: Review of Economic Dynamics. Volume 37, July 2020, Pages 214-233.
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Abstract
We analyze the interaction between fiscal consolidation and private-sector deleveraging in an economy within a monetary union. Pre-existing long term collateralized private debt – a core ingredient of the deleveraging process – plays a critical role in shaping fiscal multipliers. By buffering the short-run fall in debtors’ spending capacity, long-run private debt reduces the short-run multipliers of aggressive (large and/or fast) consolidations. However, absent credibility concerns, aggressive consolidations raise the intensity and length of private deleveraging, causing higher output losses over the medium run. In terms of discounted output losses and welfare, this latter effect dominates, so that larger and faster consolidations are relatively costlier than smaller and more gradual ones. Also, in this environment, alternative budgetary instruments generate sizable differences in terms of their incidence on private deleveraging dynamics and, hence, on the overall output costs of fiscal consolidations.