Working Paper: CEPR ID: DP7649
Authors: Giancarlo Corsetti; Keith Kuester; Andr Meier; Gernot Müller
Abstract: The global financial crisis of 2008-09 has sent public debt on sharply higher trajectories. With the economic recovery gradually taking hold, the focus is now shifting to fiscal "exit" strategies. Medium-term consolidation efforts are likely to include not only tax increases but also sizeable spending cuts. Our paper uses a standard new Keynesian model to show that the anticipation of such medium-term spending cuts generally enhances the expansionary effect of short-run fiscal stimulus. This conclusion still applies when monetary policy is constrained by the zero lower bound on policy rates. In this case, however, the reversal of government spending must not occur too early on the recovery path, or at least must be suitably gradual.
Keywords: consolidation; exit strategy; fiscal multiplier; fiscal policy; fiscal stabilization; monetary policy; zero lower bound
JEL Codes: E52; E62; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| anticipated government spending reversals (E62) | lower inflation expectations (E31) |
| lower inflation expectations (E31) | lower real interest rates (E43) |
| lower real interest rates (E43) | stimulate current demand (J23) |
| anticipated government spending reversals (E62) | enhance expansionary effects of fiscal stimulus (E62) |
| premature spending reversals (E21) | raise real interest rates (E43) |
| premature spending reversals (E21) | reduce effectiveness of fiscal stimulus (E62) |
| optimal timing of reversals (C41) | enhance fiscal multipliers (E62) |