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Dilemma for fiscal policies: supporting economic activity, or ensuring public debt sustainability?

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  • Séverine Menguy

    (Faculté Société et Humanités, Université Paris Cité, Paris, France)

Abstract

We study analytically the conflict of goals between stabilizing economic activity and public debt sustainability, for the fiscal authorities. In the short run, an active and expansionary fiscal policy, increasing public investment or reducing the labor taxation rate, is growth enhancing. However, as these short term fiscal policies also decrease government revenue and increase the public debt, budgetary and fiscal multipliers are reduced in the long run. In the framework of a potential ZLB constraint for monetary policy, an expansionary fiscal policy is thus appropriate only if long term labor and consumption taxation rates are small, and if the share of public expenditure in GDP is high. On the contrary, fiscal policy should be contractionary, in order to insure the sustainability of the long term public debt, if long term labor and consumption taxation rates are high. A contractionary fiscal policy is then also all the more appropriate as the sensitivity of government expenditure to the public debt is high, and as the labor share in the production function is high.

Suggested Citation

  • Séverine Menguy, 2024. "Dilemma for fiscal policies: supporting economic activity, or ensuring public debt sustainability?," Journal of Economic Analysis, Anser Press, vol. 3(2), pages 147-162, June.
    • Handle: RePEc:bba:j00001:v:3:y:2024:i:2:p:147-162:d:212
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    References listed on IDEAS

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    1. Henning Bohn, 1998. "The Behavior of U. S. Public Debt and Deficits," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 113(3), pages 949-963.
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