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Fiscal consolidation: Dr Pangloss meets Mr Keynes

Marcus Miller () and Lei Zhang
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Lei Zhang: University of Warwick

CAGE Online Working Paper Series from Competitive Advantage in the Global Economy (CAGE)

Abstract: A simple dynamic framework is used to show how consolidation plans that are robust and effective at capacity output can be undermined by demand failure. If the market panics and interest rates rise, the process can indeed become dynamically unstable. Tightening fiscal policy to reassure financial markets can lead to a low level “consolidation trap”, however. Better that the Central Bank acts to keep interest rates low; and that fiscal consolidation efforts be state contingent – allowing room for economic stabilisation. The pro-cyclicality of fiscal policy could also be reduced if, as Shiller has argued, debt amortization were state contingent, being indexed to GDP. Debt; Deficits; Fiscal Consolidation; Economic Stabilisation

New Economics Papers: this item is included in nep-mac, nep-pbe and nep-pke
Date: 2013
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