FiMod — A DSGE model for fiscal policy simulations

Abstract

Abstract:This paper develops a medium-scale dynamic, stochastic, general equilibrium (DSGE) model for fiscal policy simulations. Relative to existing models of this type, our model incorporates a two-country monetary union structure, which makes it well suited to simulate fiscal measures by relatively large countries in a currency area. We also provide a notable degree of disaggregation on the government expenditures side, by explicitly distinguishing between (productivity-enhancing) public investment, public purchases and the public sector wage bill. Finally, we consider a labor market characterized by search and matching frictions, which allows to analyze the response of equilibrium unemployment to fiscal measures.In order to illustrate some of its applications, and motivated by recent policy debate in the Euro Area, we calibrate the model to Spain and the rest of the area and simulate a number of fiscal consolidation scenarios. We find that, in terms of output and employment losses, fiscal consolidation is the least damaging when achieved by reducing the public sector wage bill, whereas it is most damaging when carried out by cutting public investment.Keywords: General Equilibrium, Fiscal Policy Simulations, Labor Market Search JEL codes: E24, E32, E62, H20, H50 Non-technical summaryThe recent crisis has obliged governments around the world to put in place ambitious fiscal stimulus plans and the ensuing fiscal consolidation (or "exit") strategies in order to assure fiscal stability. The latter issue is moving center stage in current public debates. In order to bring fiscal balances back on track, fiscal authorities mainly have the possibility of increasing taxes and/or cutting public spending.But which taxes should be increased? Which spending components should be cut?All across Europe, countries such as Germany, Greece, Portugal, Spain and others have put forward consolidation plans that include cuts in public employment, public wages and public investment as well as increases in VAT and labor income tax rates. Which consequences can we expect from these measures on, among others, the spillover effects of fiscal actions in one country to the other. Second, we provide a notable degree of disaggregation on the fiscal expenditures side. In particular, we explicitly distinguish between public investment and public consumption; the latter in turn is divided between public purchases and the public sector wage bill. Each of these components has a distinct effect on the rest of the economy.The model thus allows simulating specific measures that have been implemented recently in a number of European countries, such as cuts in public sector wages and/or employment, and reductions in public investment. Fiscal expenditures are completed with a number of transfers to the private sector, including unemployment benefits and lump-sum subsidies. On the fiscal revenues side, the model considers also a wide range of taxes, including taxes on consumption, labor income, returns on bond holdings and on physical capital, and socia...

Government expenditure composition and fiscal policy spillovers in small open economies within a monetary union

“…While the literature disagrees on the size and even the sign of fiscal multipliers, they are closer to an agreement that factors such as leakages into saving and imports ( Ilzetzki et al, 2013 ) and the response of monetary policy to fiscal actions ( Spilimbergo et al, 2009 ) matter. Smaller economies that are more open to trade and countries in which monetary policy offsets the fiscal stimulus will tend to have lower multipliers.…”

“…37 This has often been used to strengthen the case for greater infrastructur al spending. In the case of Ireland, ( Morgenroth, 2011 ) states explicitly that there are positive effects of government infrastructur al investment if additional infrastructure benefits the private sector. However, he also notes that government investment can have no or even negative effects if the additional infrastructure is not needed.…”

“…Had we followed the estimates from Imbs and Mejean (2015) or Corbo and Osbat (2013) , we would have to use higher values. Government spending on consumption and investment goods is specified as a fraction of steady-state nominal output, as is standard in the literature ( Baxter and King, 1993;Leeper et al, 2010;Stähler and Thomas, 2012 ). 21 We calibrate the quasi-share of imported government consumption goods to achieve a 2% of GDP government consumption ratio that is spent directly on imports in the steady state.…”

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