Fiscal Policy: Open Questions

Question 1

The consensus is that effects of fiscal consolidation on economic growth are greatest when

Answer 1

(1) the economy is performing below its potential (a negative ‘output gap’)
(2) households and firms are deleveraging and
(3) trading partners are also reducing government spending or raising taxes.
(4) The response of monetary policy also plays a role: when policy rates are already very low (as during the crisis), the central bank cannot cut them further because of the zero lower bound (liquidity trap) in order to mitigate the negative effects of fiscal consolidation.

Question 2

A high domestic debt can be associated with considerable distributional effects

Answer 2

(1) from taxpayers to interest recipients (after all, additional taxes are required to pay the interest)

(2) from future generations to the current generation (insofar
as additional taxes will be required in the future to make the repayment of the
principal and interest possible)