How Does Uncertainty about Future Fiscal Policy Affect Current Macroeconomic Variables?

Neil Rankin

Scandinavian Journal of Economics, 1998, vol. 100, issue 2, 473-494

Abstract: A dynamic stochastic general equilibrium macromodel is constructed, based on infinitely lived, dynamically optimising households with labour market monopoly power. Randomness in future government spending causes randomness in the future output and price levels, both when the money wage is flexible and when it is set one period in advance. We show that, through three different mechanisms, rational anticipation of this depresses current aggregate demand. If the wage is preset, it thereby also depresses current output. Such fiscal uncertainty is suggested as one possible explanation for the faltering of the economic recovery in Europe in 1995 and 1996.

Date: 1998
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