WHEN FISCAL CONSOLIDATION MEETS PRIVATE DELEVERAGING

We analyze the interaction between fi scal consolidation and private-sector deleveraging in an economy within a monetary union. Pre-existing long term collateralized private debt – a core ingredient of the deleveraging process – plays a critical role in shaping fi scal multipliers. By buffering the short-run fall in debtors’ spending capacity, long-run private debt reduces the short-run multipliers of aggressive (large and/or fast) consolidations. However, absent credibility concerns, aggressive consolidations raise the intensity and length of private deleveraging, causing higher output losses over the medium run. In terms of discounted output losses and welfare, this latter effect dominates, so that larger and faster consolidations are relatively costlier than smaller and more gradual ones. Also, in this environment, alternative budgetary instruments generate sizable differences in terms of their incidence on private deleveraging dynamics and, hence, on the overall output costs of fi scal consolidations.

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Abstract
We analyze the interaction between fi scal consolidation and private-sector deleveraging in an economy within a monetary union. Pre-existing long term collateralized private debt -a core ingredient of the deleveraging process -plays a critical role in shaping fi scal multipliers. By buffering the short-run fall in debtors' spending capacity, long-run private debt reduces the short-run multipliers of aggressive (large and/or fast) consolidations.
However, absent credibility concerns, aggressive consolidations raise the intensity and length of private deleveraging, causing higher output losses over the medium run. In terms of discounted output losses and welfare, this latter effect dominates, so that larger and faster consolidations are relatively costlier than smaller and more gradual ones. Also, in this environment, alternative budgetary instruments generate sizable differences in terms of their incidence on private deleveraging dynamics and, hence, on the overall output costs of fi scal consolidations.
Keywords: fi scal consolidations, long term private debt, fi nancial shock.