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Prepared by Irina Yakadina and Boriana Yontcheva.
If output falls below potential, fiscal policy can help mitigate the decline and bring output back to potential, with a goal of reducing the output gap in a reasonably short period.
The trade-off lies between the costs of additional debt and the potential benefit of higher GDP growth, whether fiscal priorities such as keeping debt ratio under control or promoting policy credibility outweigh the benefits of fiscal easing.
For more details on the French stimulus package see SR 2009
The model emphasizes these results as it takes all government investment as productive. The relative effectiveness of targeted transfers versus general transfers or tax cuts is dependent on the share of cash-constrained households.
For example, there is no sunset clause for the VAT reduction for restaurants.
In figure 4 below, all variables are presented in difference to the steady state values; for example, a drop of real GDP growth of 4.5 percent corresponds to an output contraction of 3 percent.
As the model assumes that all public investment is productive, this result may be somewhat overestimated.