New ADEMU Working Paper: Fiscal Consolidation Programs and Income Inequality

The paper Fiscal Consolidation Programs and Income Inequality was published in the ADEMU Working Paper Series. The paper focuses on the relationship between the impacts of fiscal consolidation programs across countries and time and how different income inequality levels are an important determinant for the heterogeneous effects of such programs. It is joint work with Miguel H. Ferreira, Francesco Franco, Hans A. Holter and Laurence Malafry.

We find that countries/periods where income inequality is higher fiscal consolidation programs have a higher recessive impact on output. We provide empirical evidence for such a relationship and develop a life-cycle, overlapping generations model with uninsurable labor market risk to study the mechanisms involved. We find that higher income risk induces precautionary savings behavior, which decreases the proportion of credit-constrained agents in the economy. Credit-constrained agents have less elastic labor supply responses to fiscal consolidation achieved through either tax hikes or public spending cuts, and this explains the relationship between income inequality and the impact of fiscal consolidation programs.

Click here to access the working paper.

ADEMU (A Dynamic Economic and Monetary Union) is part of the Horizon 2020 work program topic Resilient and sustainable economic and monetary union in Europe (EURO-1-2014). The primary focus of the project is on the dimension The impact of macroeconomic and social imbalances on economic stability.

ADEMU is at the frontier of dynamic macroeconomic research, and the project will generate new knowledge that will be used to provide a rigorous assessment of the current institutional framework, and detailed proposals for improving it. It will also be a focal point in debates among academics, policymakers and other stakeholders regarding the implementation of new policies. The scope of the project will include a full consideration of political economy and legal dimensions to alternative institutional reforms. Know more about ADEMU here.