Description

We build a small open economy DSGE model to evaluate the macroeconomic effects of fiscal consolidations in commodity-exporting countries. The fiscal block includes productive public capital, utility-augmenting government consumption, transfers to hand-to-mouth households, and taxes on labor and capital income as well as consumption. A country risk premium that depends on the level of foreign debt is crucial for the transmission of fiscal policy. This premium influences consumption and saving decisions of the financially unconstrained households, and the rest of the economy through general-equilibrium effects. We estimate the model with Bayesian methods using data from Ecuador, an economy with a high dependence on oil exports. We then study the macroeconomic effects of different tax and expenditure instruments. We consider a full consolidation program following the agreement between Ecuador and the IMF for the 2020-2025 period. The program reduces the country premium, which promotes private investment. Consumption of financially unconstrained households is adversely affected by higher labor income taxes, but consumption of hand-to-mouth households increases due to the expansion of government transfers under the program. In aggregate terms, GDP declines by about 1% relative to trend.