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Fiscal policy over the real business cycle: A positive theory

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  • Barseghyan, Levon
  • Battaglini, Marco
  • Coate, Stephen

Abstract

This paper explores the implications of the political economy model of Battaglini and Coate (2008) [8] for the behavior of fiscal policy over the business cycle. The model predicts that fiscal policy is counter-cyclical with debt increasing in recessions and decreasing in booms. Public spending increases in booms and decreases during recessions, while tax rates decrease during booms and increase in recessions. In both booms and recessions, fiscal policies are set so that the marginal cost of public funds obeys a submartingale. When calibrated to the US economy, the model broadly matches the empirical distribution of debt and also its negative correlation with output. However, the predictions of pro-cyclical spending and counter-cyclical taxation do not find empirical support. The calibrated model generates the same fit of the data as a benevolent government model in which the government faces an exogenous lower bound on debt. Nonetheless, the two models have very different comparative static implications.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 148 (2013)
Issue (Month): 6 ()
Pages: 2223-2265

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Handle: RePEc:eee:jetheo:v:148:y:2013:i:6:p:2223-2265

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Web page: http://www.elsevier.com/locate/inca/622869

Related research

Keywords: Fiscal policy; Business cycle; Budget deficit;

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References

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Citations

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Cited by:
  1. Alessandro Riboni & Facundo Piguillem, 2011. "Dynamic Bargaining over Redistribution in Legislatures," 2011 Meeting Papers 1320, Society for Economic Dynamics.
  2. Ruediger Bachmann, 2011. "Public Consumption Over the Business Cycle," 2011 Meeting Papers 701, Society for Economic Dynamics.
  3. Marina Azzimonti & Matthew Talbert, 2011. "Partisan cycles and the consumption volatility puzzle," Working Papers 11-21, Federal Reserve Bank of Philadelphia.
  4. Ruediger Bachmann & Jinhui Bai, 2012. "Online Appendix to "Politico-Economic Inequality and the Comovement of Government Purchases"," Technical Appendices 11-243, Review of Economic Dynamics.
  5. Battaglini, Marco & Nunnari, Salvatore & Palfrey, Thomas, 2011. "Legislative bargaining and the dynamics of public investment," Discussion Papers, Research Unit: Market Behavior SP II 2011-205, Social Science Research Center Berlin (WZB).
  6. David Miller, 2014. "Commitment versus Discretion in a Political Economy Model of Fiscal and Monetary Policy Interaction," 2014 Meeting Papers 80, Society for Economic Dynamics.
  7. Fernando M. Martin, 2011. "Government policy in monetary economies," Working Papers 2011-026, Federal Reserve Bank of St. Louis.

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