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Fiscal Austerity in Ambiguous Times

Axelle Ferriere () and Anastasios Karantounias ()

No 2016-6, FRB Atlanta Working Paper from Federal Reserve Bank of Atlanta

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.

Keywords: public consumption; intertemporal elasticity of substitution; balanced budget; austerity; fiscal consolidation; ambiguity aversion; multiplier preferences (search for similar items in EconPapers)
JEL-codes: D80 E62 H21 H63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac and nep-pbe
Date: 2016-03-01, Revised 2018-01-01
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Journal Article: Fiscal Austerity in Ambiguous Times (2019) Downloads
Working Paper: Fiscal Austerity in Ambiguous Times (2019)
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