Fiscal stimulus and exit strategies in a small euro area economy

Abstract

This article is focused on fiscal stimulus and exit strategies in a small euro area economy. The analysis is based on a New-Keynesian general equilibrium model with non-Ricardian features introduced in Almeida, Castro and Félix (2010). We define a benchmark fiscal stimulus and, conditional on alternative exit strategies, clarify its macroeconomic effects. We investigate if a fiscal stimulus can be enhanced (or harmed) by particular exit strategies. The impact multipliers proved insufficient to discriminate between alternative strategies. However, since the policy impacts are not limited to the short run, there are relevant effects over the medium run that can be used to evaluate the different strategies. It will be claimed that (i) the announcement of a promptly and timely exit strategy, contemporaneous to the announcement of the fiscal stimulus, with a consolidation period that is not prolonged indefinitively, may improve the effectiveness of the stimulus and that (ii) exit strategies based on Government consumption cuts tend to dominate over other alternatives, such as transfers cuts or tax rate increases.