Should a Government Fiscally Intervene in a Recession and, If So, How?

Taiji Harashima

MPRA Paper from University Library of Munich, Germany

Abstract: The validity of discretionary fiscal policy in a recession will differ according to the cause and mechanism of recession. In this paper, discretionary fiscal policy in a recession caused by a fundamental shock that changes the steady state downwards is examined. In such a recession, households need to discontinuously increase consumption to a point on the saddle path to maintain Pareto efficiency. However, they will not “jump” consumption in this manner and instead will choose a “Nash equilibrium of a Pareto inefficient path” because they dislike unsmooth and discontinuous consumption and behave strategically. The paper concludes that increasing government consumption until demand meets the present level of production and maintaining this fiscal policy for a long period is the best option. Consequent government debts can be sustainable even if they become extremely large.

Keywords: Discretionary Fiscal policy; Recession; Government consumption; Government debts; Pareto inefficiency; Time preference (search for similar items in EconPapers)
JEL-codes: E20 E32 E62 H20 H30 H63 (search for similar items in EconPapers)
Date: 2017-04-02
New Economics Papers: this item is included in nep-mac and nep-pbe
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:78053

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