American Economic Journal:
Macroeconomics
ISSN 1945-7707 (Print) | ISSN 1945-7715 (Online)
Fiscal Austerity in Ambiguous Times
American Economic Journal: Macroeconomics
vol. 11,
no. 1, January 2019
(pp. 89–131)
Abstract
This paper analyzes optimal fiscal policy with ambiguity aversion and endogenous government spending. We show that, without ambiguity, optimal surplus-to-output ratios are acyclical and that there is no rationale for either reduction or further accumulation of public debt. In contrast, ambiguity about the cycle can generate optimally policies that resemble "austerity" measures. Optimal policy prescribes higher taxes in adverse times and front-loaded fiscal consolidations that lead to a balanced primary budget in the long-run. This is the case when interest rates are sufficiently responsive to cyclical shocks, that is, when the intertemporal elasticity of substitution is sufficiently low.Citation
Ferriere, Axelle, and Anastasios G. Karantounias. 2019. "Fiscal Austerity in Ambiguous Times." American Economic Journal: Macroeconomics, 11 (1): 89–131. DOI: 10.1257/mac.20160085Additional Materials
JEL Classification
- D81 Criteria for Decision-Making under Risk and Uncertainty
- E32 Business Fluctuations; Cycles
- E43 Interest Rates: Determination, Term Structure, and Effects
- E62 Fiscal Policy
- H21 Taxation and Subsidies: Efficiency; Optimal Taxation
- H61 National Budget; Budget Systems
- H63 National Debt; Debt Management; Sovereign Debt
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