Working Paper: NBER ID: w11869
Authors: David B. Gordon; Eric M. Leeper
Abstract: Economists generally believe that countercyclical fiscal policies have stabilizing effects that work through automatic stabilizers and discretionary actions. Analyses underlying this conventional wisdom focus on intratemporal margins: how employment and personal income respond in the short run to changes in government expenditures and taxes. But in economic downturns, countercyclical policies increase government indebtedness, raising future debt service obligations. These new expenditure commitments must be financed by some mix of higher taxes, lower spending, or higher money growth in the future. Expectations of how future policies will adjust change current savings rates and the efficacy of countercyclical policies. It is thus possible for responses to expected future policies to exacerbate and prolong recessions. This paper highlights these expectations effects. Connecting the theory to U.S. data we find: (1) through this expectations channel, countercyclical policies may create a business cycle when there would be no cycle in the absence of countercyclical policies; (2) nontrivial fractions of variation in investment and velocity can be explained by variation in macro policies alone---without any nonpolicy sources of fluctuation; and (3) persistence in key macro variables can arise solely from expectations of policy.
Keywords: No keywords provided
JEL Codes: E32; E62; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Countercyclical policies (E63) | Business cycle (E32) |
| Anticipation of future tax increases (H26) | Reduction in current investment (G31) |
| Reduction in current investment (G31) | Prolonged economic downturns (E32) |
| Macroeconomic policy variations (E65) | Variation in investment and velocity (E41) |
| Expectations of future policies (E60) | Current economic performance (E66) |
| Countercyclical policies (E63) | Investment (G31) |
| Countercyclical policies (E63) | Output (Y10) |