Publications

We quantify the impact of demographic change on real interest rates, house prices and household debt in an overlapping-generations model. Falling birth and death rates across advanced economies can explain much of the observed fall in real interest rates and the rise in house prices and household debt. Since households maintain relatively high wealth levels throughout retirement, these trends will persist as population ageing continues. Countries ageing relatively slowly, like the US, will increasingly accumulate net foreign liabilities. The availability of housing as an alternative store of value attenuates these trends, while raising the retirement age has limited effects.

Implementation of fiscal surveillance rules relies heavily on the proper interpretation of legal terms, creating a need to infuse economic insight into legal analysis. Rigid legal application of fiscal deficit rules may curtail structural reforms, as reforms can go against fiscal consolidation in the short run. However, if reforms are expected to improve public finances in the long run, they should not be viewed as incompatible with the legal framework. Focussing on the case of EU fiscal surveillance, this paper identifies the circumstances under which the positive budgetary long-term effect of structural reforms materialize in such a way that the legal rules should be applied with a degree of leniency, allowing for a short-term deterioration of the fiscal position. To that end, we quantify the short-run fiscal costs and long-run fiscal benefits of reforms, and investigate how the design of reforms can affect this trade-off. Results suggest that as short run output losses of reforms are alleviated by fiscal stimulus, long run output gains from the reforms imply that fiscal viability can be reached within a reasonable period of time. Product market reforms are generally preferable over labour market reforms, as they have a larger impact on fiscal revenues. These insights inform the legal analysis in several regards. First, the economic analysis is in line with teleological interpretation of legal rules aimed at ensuring long-term fiscal stability, while allowing short-term fiscal leniency. Second, the economic analysis can give contours to vague legal terms, such as "prompt" positive budgetary effects and the legal requirement of "major" structural reforms, showing that the type of reform matters as much as the size of the reform, and that while larger reforms have larger long run budgetary effects, they also require greater leniency in the short run. More generally, our analysis calls for the design and interpretation of legal fiscal regimes with reference to the interdependency between fiscal policy and structural economic policies.

Structural reforms, in particular reductions in mark-ups in product and labour markets, can entail short run output costs unless offset by a demand expansion. When monetary policy is constrained and cannot carry out this short run expansion, there is a potential role for fiscal policy. Although this idea has received a lot of attention in the policy debate, there has been little formal study of the fiscal consequences of reforms under constrained monetary policy. This paper uses a model to quantify the short run fiscal costs and long run fiscal benefits of reforms, in order to see to what extent the latter justify the former. The fiscal costs and benefits of reforms are both generally found to be small, although larger reforms entail larger rises in deficit-to-GDP in the short run. Results suggest that reforms in labour markets have little effect on public finances in the long run, but their short run costs can be ameliorated if combined with product market reforms.

We construct a model of a monetary union to study fiscal consolidation in the Periphery of the Euro area, through cuts in public sector wages or hiring when the nominal interest rate is constrained at its lower bound. Consolidation induces a positive wealth effect that increases demand, as well as a reallocation of workers towards the private sector, which together boost private activity. However, in a low inflation environment, demand is suppressed and the private sector is not able to absorb the additional workers. Comparing the two instruments, cuts in public hiring increase unemployment persistently in this environment, while wage cuts can reduce it. Regions with higher mobility of labor between the two sectors are able to consolidate more effectively. Price flexibility is also key at the zero lower bound: for a higher degree of price rigidity in the Periphery, consolidation becomes harder to achieve. Consolidations can be self-defeating when the public good is productive.

Across the industrialised world, real interest rates and nominal investment rates have fallen, while house prices and household debt ratios have risen. We present a calibrated OLG model which quantifies how much of these four trends can be explained with a fifth - the widespread fall in the relative price of investment goods. Relative to other explanations for low real interest rates, this trend is important because it can also account for the fall in nominal investment rates. The model can reproduce a small but economically significant part of the fall in interest rates, a larger part of the observed fall in the investment rate, and a sizeable part of the rises in house prices and household debt.

Cross country evidence highlights the importance of tax evasion and corruption in determining the size of fiscal multipliers. We introduce these two features in a New Keynesian model and revisit the effects of fiscal consolidation. VAR evidence for Italy suggests that spending cuts reduce tax evasion, while tax hikes increase it. In the model, spending cuts induce a reallocation of production towards the formal sector, thus reducing tax evasion. Tax hikes increase the incentives to produce in the less productive shadow sector, implying higher output and unemployment losses. Corruption further amplifies these losses by requiring larger hikes in taxes to reduce debt. We use the model to assess the recent fiscal consolidation plans in Greece, Italy, Portugal and Spain. Our results corroborate the evidence of increasing levels of tax evasion during these consolidations and point to significant output and welfare losses, which could be reduced substantially by combating tax evasion and corruption.