The simple macroeconomics of fiscal austerity: Public debt,deficits and deficit caps

Thomas Palley

European Journal of Economics and Economic Policies: Intervention, 2012, vol. 9, issue 1, 91-108

Abstract: This paper explores the macroeconomics of fiscal austerity. A binding budget deficit cap makes the economy more volatile by turning the government budget into an automatic destabilizer. Public debt helps maintain aggregate demand (AD) in the presence of a lower price level because a lower price level increases the real value of public interest payments and also has a positive wealth effect. That makes public debt significantly different from private debt. If the economy is subject to a binding deficit cap public debt may no longer stabilize output. This is because increased real interest payments may be matched by spending cuts, giving rise to a negative balanced budget multiplier.

Keywords: Â fiscal austerity; budget deficit cap; public debt; lower price level (search for similar items in EconPapers)
JEL-codes: E12 E60 E62 H62 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:elg:ejeepi:v:9:y:2012:i:1:p91-108

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