Fiscal Austerity in Ambiguous Times

Axelle Ferriere and Anastasios Karantounias

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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.

Date: 2019-01
Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-02084280v1
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Citations: View citations in EconPapers (7)

Published in American Economic Journal: Macroeconomics, 2019, 11 (1), pp.89-131. ⟨10.1257/mac.20160085⟩

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Related works:
Journal Article: Fiscal Austerity in Ambiguous Times (2019)
Working Paper: Fiscal Austerity in Ambiguous Times (2019)
Working Paper: Fiscal Austerity in Ambiguous Times (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:halshs-02084280

DOI: 10.1257/mac.20160085

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