Working Paper: CEPR ID: DP13740
Authors: Paul De Grauwe; Yuemei Ji; Pasquale Foresti
Abstract: We introduce fiscal policies into a behavioral macroeconomic model. We show how animal spirits play an important role in the dynamics of the business cycle and of public debt. These animal spirits are able to generate different sizes of fiscal multipliers depending on the state of the economy. Depending on the interest rate regime (high or low), they affect the capacity of fiscal authorities to stabilize the economy. In the high interest rate regime the fiscal authorities face a steep trade-off between output stabilization and the stabilization of public debt, i.e. attempts to stabilize the business cycle quickly hit a limitation of debt sustainability. In the low interest rate regime, when the steady state interest rate is lower than the growth rate of the economy, the use of fiscal policy as a tool of output stabilization is made considerably stronger.
Keywords: fiscal policy; public debt; sustainability; fiscal multiplier; low and high interest rate regimes; tradeoffs
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Animal spirits (E32) | Output gap (E23) |
| Output gap (E23) | Public debt (H63) |
| Animal spirits (E32) | Public debt (H63) |
| Fiscal policy effectiveness (E62) | Economic conditions (E66) |
| Economic conditions (E66) | Fiscal multipliers (E62) |
| Interest rate regimes (E43) | Trade-offs for fiscal authorities (E62) |