Short Run Costs of Structural Reforms

Structural reforms that increase competition in product markets, or increase flexibility in labour markets, can entail short run output costs unless offset by a demand expansion. When monetary policy is constrained and cannot carry out this short run expansion, there is a potential role for fiscal policy. This chapter quantifies these short run fiscal costs and long run fiscal benefits of reforms, and investigates how the design of reforms can affect this trade-off. In the model, both the costs and benefits of reforms are generally small, although increasingly large reforms entail larger rises in deficit-to-GDP in the short run. Results suggest that reforms in labour markets have little effect on public finances in the long run, but can help to ameliorate the short run costs of product market reforms.