Effects of fiscal consolidation

Governments should make reductions of public debt and fiscal deficits their immediate priority.

Report on Debate

Introduction

Fiscal austerity is a hotly debated topic in many countries. While some economists believe that cutting governmental expenditure is the only way out of the crisis, others think that decreasing spending while the economy is weak will just worsen the crisis. In this report, the effects of fiscal consolidation will be analysed with the help of the IS-LM-FX model, in order to highlight what outcomes governments can expect following a cut in fiscal spending.

Methods of fiscal consolidation

If we are speaking about the debt, we should mention that there are two generally used ways/practices to decrease the debt: either to decrease governmental expenditures, or to increase the taxes. Both methods can be very effective, but there are obvious differences. Increase in taxes can be implemented to some certain extent and it can't be done «each time». Anyway, the influence of both measures on the macroeconomic data is practically the same, so we have discovered all possible negative effect on the economy, which derive when the fiscal austerity policy is implemented.

Effects of fiscal consolidation

Our analysis of fiscal austerity is based on IS-LM model implemented for two cases separately: for economies with Flexible and Fixed Exchange rates. We highlighted the consequences only of decrease in governmental expenditures, skipping the effect of changes in tax regime. It is a deliberate decision in order to provide a clear logic of the model not overloaded with complexity. Also we concentrated only on the short-term as the fiscal austerity in the long term could be reasonable and beneficial under certain conditions.

Assuming that governmental expenditures decreases in order to decrease fiscal deficit, an aggregated demand in the country would also fall (Keynesian cross model could be implied). Consequently, these changes cause the fall of the goods market and shit of market equilibrium state, because of excessive supply.

Дата добавления: 2015-10-29