Fiscal Consolidation Strategy: An Update for the Budget Reform Proposal of March 2013

Research Area: Macroeconomics, Fiscal Policy
Researcher: John F. Cogan,
John B. Taylor,
Volker Wieland,
Maik Wolters
Date: Jan 2013
Abstract:

The authors evaluated a fiscal consolidation strategy for the United States that would bring the government budget into balance by gradually reducing government spending relative to GDP to the ratio that prevailed prior to the crisis (Cogan et al, JEDC 2013) and published an analysis of the macroeconomic consequences of the 2013 Budget Resolution that was passed by the U.S. House of Representatives in March 2012.

In this note, the authors provide an update of the research that evaluates the current budget reform proposal that is to be discussed and voted on in the House of Representative in March 2013. Contrary to the views voiced by critics of fiscal consolidation, the authors show that such a reduction in government purchases and transfer payments can increase GDP immediately and permanently relative to a policy without spending restraint. The research makes use of a modern structural model of the economy that in corporates the long-standing essential features of economics: opportunity costs, efficiency, foresight and incentives. GDP rises because households take into account that spending restraint helps avoid future increases in tax rates. Lower taxes imply less distorted incentives for work, investment and production relative to a scenario without fiscal consolidation and lead to higher growth.

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