Table 1: Calibration
Preferences parameters Technology parameters

β
0.98

σ
2

ϕ
2.675

α
1/3

θ
0

δ
0.1

Macroeconomic and fiscal policy variables 1965-1970 1971-1975 1976-1980 1981-1985 1986-1990 Real per capita growth rate Effective tax rates on labor income Effective tax rates on capital income Replacement rate Public employment/labor force Gov. non-wage consumption/GDP Debt/GDP 3.94 27.42 23.79 17.42 12.99 4.83 41.25 2.79 32.67 27.44 21.5 15.15 5.26 37.45 2.58 36.69 33.67 24.64 17.13 5.71 39.51 1.47 39.12 35.95 26.94 18.25 5.93 52.5 2.69 41.5 36.88 28.51 18.82 6.08 59.04 1991-1995 0.64 42.6 34.8 32.15 18.71 6.57 70.54 Average 2.41 36.67 32.09 25.17 16.76 5.70 50.36

Steady state variables 1965-1970 1971-1975 1976-1980 1981-1985 1986-1990 K/Y I/Y C/Y Np 1.25 0.17 0.83 0.12 1.36 0.17 0.83 0.10 1.27 0.16 0.84 0.09 1.42 0.16 0.84 0.08 1.19 0.15 0.85 0.07 1991-1995 1.63 0.17 0.83 0.06 Average 1.33 0.17 0.83 0.08

Countries in the sample: Belgium, Finland, France, Germany, Italy, Netherlands, Norway, Spain, Sweden, UK

Table 2: Effects of 1% increase in fiscal policy items
Percentage deviation from pre-change balance growth path equilibrium Impact effect Long-run effect Impact effect Long-run effect Impact effect Long-run effect Impact effect Long-run effect Impact effect Long-run effect

Δg
Effect on macroeconomic variables y k Np r w c L 0.05 0 0.07 0.05 -0.02 -0.03 -0.01 0.07 0.07 0.07 0 0 -0.01 -0.01

ΔN g

Δtr

Δτ N

Δτ k

-0.14 0 -0.22 -0.14 0.07 -0.13 -0.20

-0.20 -0.20 -0.20 0 0 -0.20 -0.20

-0.42 0 -0.63 -0.42 0.21 -0.38 0.08

-0.59 -0.59 -0.59 0 0 -0.59 0.07

-0.62 0 -0.92 -0.62 0.31 -0.55 0.11

-0.86 -0.86 -0.86 0 0 -0.86 0.10

-0.10 0 -0.14 -0.10 0.05 0.07 0.02

-0.33 -0.80 -0.09 0.47 -0.24 -0.23 0.01

Welfare cost

0.03

0.69

0.33

0.48

0.11

Effect on public finance Primary deficit Primary deficit/y Debt Debt/y -0.01 -0.06 0 -0.05 0.01 -0.05 -0.96 -1.02 0.38 0.52 0 0.14 0.30 0.51 0.38 0.57 1.11 1.54 0 0.42 0.88 1.48 2.35 2.90 0.16 0.78 0 0.62 -0.16 0.71 3.66 4.49 0.03 0.12 0 0.10 -0.27 0.05 3.34 3.61

Data are given as percentage deviations from to the pre-policy change balanced-growth equilibrium. Impact effects correspond to changes at the time of the increase in the fiscal policy item. Long-run effects measure deviations between the post and pre-policy change balanced-growth equilibria. For Debt and Debt/y, the long-run effect corresponds to the percentage deviation of the two variables relative to the pre-policy change equilibrium ten years after the policy change occurred. y = GDP, k = capital stock, Np = work hours in the private sector, r = real interest rate, w = wage rate, c = consumption, L = leisure hours. The welfare cost of a policy is computed as the percentage change in consumption needed to equate lifetime utility after the policy change to lifetime utility in the pre policy change case. Primary deficit: a positive change in the primary deficit means that the primary balance deteriorates with respect to its value in the pre-policy change balanced-growth equilibrium.

Figure 1: Effect of 1% increase in government non-wage consumption - benchmark model

0.08 0.07 0.06 0.05 0.04 0.03 0.02 0.01 0 1 2 3 4 5 6 7 K 8 Np 9 Y 10 11 12 13 14 15

0.06 0.05 0.04 0.03 0.02 0.01 0 -0.01 -0.02 -0.03 r w 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

0 1 -0.01 Utility, consumption -0.02 -0.03 -0.04 -0.05 -0.06 Utility Consumption Leisure 2 3 4 5 6 7 8 9 10 11 12 13 14 15

-0.0077 -0.0078 -0.0079 -0.008 -0.0081 -0.0082 -0.0083 -0.0084 -0.0085 -0.0086 -0.0087 Leisure
Pr. Deficit

0.02 0.015 0.01 0.005 0 1 -0.005 -0.01 -0.015 -0.02 Pr. Deficit Debt 2 3 4 5 6 7 8 9 10 11 12 13 14 15

0 -0.2 -0.4 -0.6 -0.8 -1 -1.2 -1.4 -1.6
Debt

Data plotted are percentage deviation from the pre policy change balanced growth path equilibrium. Pr. Deficit: a positive change in the primary deficit means that the primary balance deteriorates with respect to its value in the pre-policy change balanced-growth equilibrium

Figure 2: Effect of 1% increase in public employment - benchmark model

0 1 -0.05 2 3 4 5 6 7 8 9 10 11 12 13 14 15

0.1 0.05 0 1 -0.05 2 3 4 5 6 7 8 9 10 11 12 13 14 15

-0.1

-0.15 -0.1 -0.2 -0.15 -0.25 -0.2 K Np Y r w

0.39 -0.199 -0.14 -0.24
Utility, consumption
Pr. Defict

0.45 0.4 0.35 0.3
Debt

0.38 0.37 0.36

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15 -0.1995 -0.2
Leisure

-0.34 -0.44 -0.54 -0.64 -0.74 Utility Consumption Leisure

0.35 0.34 0.33 0.32 0.31 0.3

0.25 0.2 0.15 0.1 0.05 0 1 2 3 4 5 6 7 8 9 10 Debt 11 12 13 14 15

-0.2005 -0.201 -0.2015 -0.202

Pr. Deficit

Data plotted are percentage deviation from the pre policy change balanced growth path equilibrium. Pr. Deficit: a positive change in the primary deficit means that the primary balance deteriorates with respect to its value in the pre-policy change balanced-growth equilibrium.

Figure 3: Fiscal contraction - benchmark model Output 0.8 0.6 0.4 0.2 0 -0.2 -0.4 -0.6 -0.8 -1 1 0.5 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 -0.5 -1 -1.5 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Employment in private sector

Utility

Primary deficit

0.8 0.6 0.4 0.2 0 -0.2 -0.4 -0.6 -0.8 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

0.4 0.2 0 -0.2 -0.4 -0.6 -0.8 -1 -1.2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Data plotted are percentage deviation from the pre-policy change balanced growth path equilibrium. Pr. Deficit: a positive change in the primary deficit means that the primary balance deteriorates with respect to its value in the pre-policy change balanced-growth equilibrium Public employment -1% Government non-wage consumption -1% Capital tax +1% Labor tax +1% Transfers -1%

Figure 4: Effect of 1% increase in public employment - sensitivity analysis Output 1.4 1.2 1 0.8 0.6 0.4 0.2 0 -0.2 -0.4 0 1 -0.05 -0.1 -0.15 -0.2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 -0.25 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Employment in private sector

Utility 0.8 0.6 0.4 0.2 0 -0.2 -0.4 -0.6 -0.8 -1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 1 2 3 4 5

Primary deficit

6

7

8

9

10

11

12

13

14

15

Data plotted are percentage deviation from the pre-policy change balanced growth path equilibrium. Pr. Deficit: a positive change in the primary deficit means that the primary balance deteriorates with respect to its value in the pre-policy change balanced-growth equilibrium θ=0 θ=1 θ=1/3 x ϕ=0