Fiscal Financing in a Wartime Economy : A Small Open Economy DSGE Model for Sweden

Sammanfattning

This thesis constructs a small open economy DSGE model calibrated to Swedish data and simulate a hypothetical five-year conventional invasion of Sweden. The war is constructed as a shock which combines three exogenous channels: a destruction of private capital, a decline in total factor productivity, and a surge in military expenditure. To cover the growing budget deficit three financing options for the government are compared and evaluated based on their distortionary impact, pure debt financing, a labor tax and a capital tax. Under pure debt financing, the baseline simulation produces an output decline of about 28 percent, a fall in private consumption of 13 percent, an investment contraction of close to 50 percent, and a real-wage decline of roughly 27 percent. Among fiscal adjustment regimes, capital taxation is most disruptive, while labor taxation primarily negatively impact consumption and debt financing minimizes short-run distortions at the cost of long-run unsustainability. This qualitative ranking of fiscal regimes is robust across different war-severity scenarios