Fiscal Policy, Debt Consolidation and the Consequences of the Great Recession

This thesis examines the domestic and international transmission of fiscal shocks, especially in the wake of the European sovereign debt crisis after the Great Recession. The thesis is divided into three main chapters, with each chapter addressing contemporary policy questions in recent macroeconomic debates. The first chapter investigates the effect of fiscal consolidation on different types of household, and how the degree of household's financial constraints interacts with the government's debt-consolidation plan in a dynamic stochastic general equilibrium (DSGE) model estimated on UK data. In the second chapter, the analysis is extended to a two-country model in order to investigate the international transmission of fiscal shocks between the UK and the Euro area, and how the relative participation of these countries at the global asset market influence cross-border fiscal spillovers. Motivated by the recent calls on the German government to increase its spending, the third chapter estimates the international spillover effects of an expansion in German government spending on output and bilateral exchange rates of 15 European (10 Euro and 5 non-Euro) economies within a sign-restricted structural VAR model.
Evidence from the closed-economy model shows that different types of households respond differently to fiscal consolidation shocks, depending on the degree of financial constraints they face. Tighter household's credit constraints dampen the responsiveness of fiscal instruments to government debt, thereby prolonging the actualisation of the consolidation plan. On the international transmission of fiscal shock, the results show that EA fiscal shocks have sizeable effects on the UK economy, while UK fiscal shocks have negligible effects on the EA economy. Also, relative countries' participation at the international asset market drives the amplification and propagation of cross-border fiscal spillovers. Furthermore, German government spending shock has moderate but short-lived effects on the output of other European countries, with homogeneous responses in the Euro countries, but heterogeneous responses in non-Euro countries.