Working Paper: CEPR ID: DP7302
Authors: Giancarlo Corsetti; Andr Meier; Gernot J. Müller
Abstract: The impact of fiscal stimulus depends not only on short-term tax and spending policies, but also on expectations about offsetting measures in the future. This paper analyzes the effects of an increase in government spending under a plausible debt-stabilizing policy that systematically reduces spending below trend over time, in response to rising public liabilities. Accounting for such spending reversals brings an otherwise standard new Keynesian model in line with the stylized facts of fiscal transmission, including the crowding-in of consumption and the `puzzle' of real exchange rate depreciation. Time series evidence for the U.S. supports the empirical relevance of endogenous spending reversals.
Keywords: consumption; fiscal policy; transmission; monetary policy; real exchange rate; real interest rates; sticky prices
JEL Codes: E62; E63; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in government spending (H59) | Enhancement of the expansionary impact of fiscal stimulus (E62) |
| Expected spending reversals (H68) | Enhancement of the expansionary impact of fiscal stimulus (E62) |
| Spending reversals (E62) | Future declines in short-term rates (E43) |
| Future declines in short-term rates (E43) | Adjustment in real output (E23) |
| Anticipation of future spending cuts (D84) | Alignment of consumption demand across households (D12) |
| Fiscal expansions (E62) | Boost in private consumption (D19) |
| Fiscal expansions (E62) | Boost in output (E23) |
| Government spending reversals (E62) | Time path of real interest rates (E43) |
| Crowding-in of consumption (D12) | Depreciation of the real exchange rate (F31) |