Debt Hangover in the Aftermath of the Great Recession

Abstract

Following the Great Recession, U.S. government debt levels exceeded 100% of output. We develop a macroeconomic model to evaluate the role of various shocks during and after the Great Recession; labor market shocks have the greatest impact on macroeconomic activity. We then evaluate the consequences of using alternative fiscal policy instruments to implement a fiscal austerity program to return the debt-output ratio to its pre-Great Recession level. Our welfare analysis reveals that there is not much difference between applying fiscal austerity through government spending, the labor income tax, or the consumption tax; using the capital income tax is welfare-reducing.