the importance of financing we show in this section the long term effects of a permanent
fiscal expansion in all EU countries under different financing assumptions, namely an
increase in labour income tax, an increase in corporate tax and an increase in VAT 10. These
alternative scenarios are simulated with the steady state version of the model and show the
long term effects after all adjustments have taken place. The shock is a permanent increase
of 1 percentage point in the share of government purchases in total GDP in all EU member
states. It is assumed that monetary authorities target the price level and that the GDP deflator
is constant in the long run.
In the first scenario it is assumed that the increase in public spending is paid for by a
reduction in (lump sum) transfers from the government to households, which is the standard
assumption in the model. A fiscal expansion funded by a reduction in transfer payments has
clearly the smallest crowding-out effects (see Table 11.a). The long term effect on output is
positive, due to higher labour supply which raises potential output and employment increases
slightly. The increase in labour supply stems from the fall in the value of leisure which
reduces the reservation wage. This in turn is caused by the drop in private consumption as
transfers to households are reduced. The expansion in output is accompanied by a small
depreciation of the exchange rate.
When the fiscal expansion is funded by an increase in labour taxes, there are large negative
employment effects (see Table 11.b). Employment falls by between 0.5 and 1.8 per cent in
the long run. On average, output is around 1.2 percent lower in the new steady state. The fall
in consumption is even larger than in the previous scenario with a reduction in transfers.
Employment effects are small in the third scenario where corporate taxes are increased to pay
for the increase in fiscal spending (see Table 11.c). Higher corporate taxation imply lower
investment by firms and lead to a lower capital stock. This implies a considerably lower
level of potential output in the new steady state. Finally, when the fiscal expansion is funded
by a VAT increase, the net output effects is slightly negative (see Table 11.d). The VAT
increase reduces consumption and output and employment are both lower in the new steady
state.
Table 11.a: Effects of permanent EU wide fiscal expansion financed by cut in transfers to
households
|
GDP |
private |
cons |
invest. |
empl. |
wages |
cons deflator |
GDP |
trade | |
|
DE |
018 |
0.20 |
-126 |
0"26 |
014 |
0"03 |
-0.11 |
-0.19 |
-0.02 |
|
FR |
0.17 |
0.19 |
-1.34 |
0.24 |
0.12 |
0.03 |
-0.06 |
-0.17 |
-0.02 |
|
IT |
0.12 |
0.13 |
-1.32 |
0.17 |
0.09 |
0.02 |
-0.04 |
-0.12 |
-0.02 |
|
UK |
0.17 |
0.18 |
-1.32 |
0.21 |
0.15 |
0.01 |
-0.03 |
-0.17 |
0.00 |
|
ES |
0.14 |
0.15 |
-1.36 |
0.19 |
0.11 |
0.02 |
-0.04 |
-0.14 |
-0.02 |
|
NL |
0.11 |
0.12 |
-1.25 |
0.16 |
0.08 |
0.02 |
-0.01 |
-0.11 |
-0.02 |
|
BE |
0.17 |
0.19 |
-1.20 |
0.21 |
0.14 |
0.01 |
-0.06 |
-0.17 |
-0.01 |
|
DK |
0.15 |
0.18 |
-1.41 |
0.22 |
0.11 |
0.02 |
0.02 |
-0.15 |
-0.03 |
|
IR |
0.18 |
0.20 |
-1.24 |
0.24 |
0.14 |
0.02 |
-0.06 |
-0.18 |
-0.02 |
|
PO |
0.11 |
0.13 |
-1.54 |
0.16 |
0.08 |
0.02 |
0.00 |
-0.11 |
-0.02 |
|
GR |
0.11 |
0.13 |
-1.33 |
0.16 |
0.09 |
0.02 |
-0.01 |
-0.11 |
-0.02 |
|
OS |
0.09 |
0.10 |
-1.38 |
0.16 |
0.06 |
0.03 |
0.03 |
-0.09 |
-0.03 |
|
SW |
0.11 |
0.13 |
-1.38 |
0.18 |
0.07 |
0.03 |
0.00 |
-0.11 |
-0.01 |
|
SF |
0.11 |
0.13 |
-1.23 |
0.18 |
0.08 |
0.03 |
0.00 |
-0.11 |
-0.02 |
|
EU15 |
0.15 |
0.17 |
-1.31 |
0.22 |
0.12 |
0.02 |
-0.05 |
-0.15 |
-0.02 |
Note: Percentage difference from base, * GDP deflator at market prices, ** trade balance as percentage of GDP (absolute difference from base)
10 Roeger and in ’t Veld (1997b) contains a more detailed analysis of the different effects under
various tax and spending assumptions.
29