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Fiscal Austerity in Ambiguous Times

Axelle Ferriere () and Anastasios Karantounias ()

American Economic Journal: Macroeconomics, 2019, vol. 11, issue 1, 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.

JEL-codes: D81 E32 E43 E62 H21 H61 H63 (search for similar items in EconPapers)
Date: 2019
Note: DOI: 10.1257/mac.20160085
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Handle: RePEc:aea:aejmac:v:11:y:2019:i:1:p:89-131