International Finance Discussion Papers (IFDP)

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April 2012

Fiscal Consolidation in an Open Economy

Christopher J. Erceg and Jesper Linde

Abstract:

This paper uses a New Keynesian DSGE model of a small open economy to compare how the e¤ects of fiscal consolidation di¤er depending on whether monetary policy is constrained by currency union membership or by the zero lower bound on policy rates. We show that there are important di¤erences in the impact of fiscal shocks across these monetary regimes that depend both on the duration of the zero lower bound and on features that determine the responsiveness of inflation.

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Keywords: Monetary policy, currency union, fiscal policy, zero lower bound constraint, new Keynesian small open economy DSGE model

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Last Update: July 10, 2020