Metelli, Luca
(2015)
Essays in macroeconomics.
PhD thesis, London School of Economics and Political Science.
Abstract
The thesis contains three chapters. The first chapter studies optimal fiscal policy in a small open economy in the presence of sovereign default risk. In particular, it studies this topic in an environment characterized by asymmetric information where financial markets (lenders) do not have enough information about the creditworthiness of the government (borrower). The chapter investigates whether the asymmetric information environment justifies the implementation of fiscal austerity during a recession, as opposed to the standard countercyclical response. The main finding is that fiscal austerity is the optimal fiscal policy during a recession. Fiscal austerity, although detrimental to economic growth, benefits the economy providing a signal to financial markets about the creditworthiness of the government and reducing borrowing costs. When the inherited government debt-to-GDP ratio is high, this beneficial effect of fiscal austerity outweighs the costs of the policy even when fiscal austerity has a strong negative impact on economic activity, i.e. when the fiscal multiplier is larger than one. The findings of this chapter are useful to shed new light on the fiscal policy developments across Europe during the European debt crisis.
The second chapter of the thesis, co-authored with Maria Grazia Attinasi (ECB), studies empirically the effect of fiscal consolidation on the debt-to-GDP ratio for the Euro area countries, using a quarterly panel fiscal VAR. The main finding of this chapter is that following a fiscal consolidation episode, the debt-to-GDP ratio increases initially, for a period up to four quarters, and then starts to decline. The size and length of the initial debt increase depend on the composition of consolidation. In the case of revenue-based consolidations the increase in the debt-to-GDP ratio tends to be larger and to last longer than in the case of spending-based consolidations. The composition also matters for the long term effects of fiscal consolidations. Spending-based consolidations tend to generate a durable reduction of the debt-to-GDP ratio compared to the pre-shock level, whereas revenue-based consolidations do not produce any lasting improvement in the sustainability prospects as the debt-to-GDP ratio tends to revert to the pre-shock level. The findings of this chapter are of particular policy relevance in the context of the ongoing debate about the merits of fiscal consolidation as the main tool to restore debt sustainability in the Euro area countries. They suggest that short term considerations related to the detrimental impact of consolidation on growth and
on the debt-to-GDP ratio need to be weighed against the long term benefits of a rebound in output growth and a durable reduction in the debt-to-GDP ratio.
The third chapter, co-authored with Daniela Bragoli (Catholic University) and Michele Modugno (Federal Reserve Board), compares the forecasting performance of GDP now-casting techniques through a dynamic factor model to the forecasts produced by the Central Bank of Brazil, which is the only central bank that collects predictions at a daily frequency. Results indicate that the Central Bank of Brazil forecasts perform as well as model based forecasts. The latter finding suggests that, on the one hand, judgemental forecasters do not have computational limitations and they are able to incorporate quickly new information in a way that
is almost as efficient as a machine. On the other hand, it shows that a linear time invariant model does a slightly better job in now-casting Brazilian GDP and hence that eventual non linearities, time variations and soft information that could be incorporated by judgement, do not provide new important information.
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