A new deliverable on government debt deleveraging by Alexandre Lucas Cole (LUISS Guido Carli), Chiara Guerello (LUISS Guido Carli), and Guido Traficante (European University of Rome) has been published today:
Abstract: We evaluate the stabilization properties and welfare implications of different government debt deleveraging schemes and instruments for deleveraging in a currency union. In a two-country new-Keynesian DSGE model, with a debt-elastic government bond spread and incomplete international financial markets, we study the effects of government debt deleveraging, under a range of alternative shocks and under alternative scenarios for fiscal policy coordination. We find that greater stabilization is achieved by backloading the deleveraging process and when the two countries reduce the net exports gap. Moreover, taxes are a better instrument for deleveraging compared to government consumption or transfers. Our policy prescriptions for the Eurozone are to reduce government debt more gradually over time and less during recessions and to do so using distortionary taxes, while concentrating on reducing international demand imbalances.