Working Paper: CEPR ID: DP599
Authors: Giuseppe Bertola; Allan Drazen
Abstract: We present and analyse an optimizing model which explains the counter-intuitive effects of fiscal policy in terms of expectations. If government spending follows an upward-trending stochastic process, which the public believes may fall sharply when it reaches specific `target points', then optimizing consumption behaviour and simple budget constraint arithmetic imply a non-linear relationship between private consumption and government spending. This theoretical relation is consistent with the experience of several countries.
Keywords: fiscal austerity; government spending; consumption; economic policy
JEL Codes: E62; H30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government spending (H59) | Consumption (E21) |
| Expectations of future fiscal policy changes (E62) | Consumption (E21) |
| Government spending (H59) | Current private spending (D19) |
| Government spending (upward trend) (H59) | Consumption (diminished response) (E21) |
| Future fiscal stabilization (E63) | Consumption behavior (D10) |
| Fiscal contractions (E62) | Unexpected expansions in consumption (E21) |