We present and analyse an optimizing model which explains the counter-intuitive effects of fiscal policy in terms of expectations. If government spending follows an upward-trending stochastic process, which the public believes may fall sharply when it reaches specific `target points', then optimizing consumption behaviour and simple budget constraint arithmetic imply a non-linear relationship between private consumption and government spending. This theoretical relation is consistent with the experience of several countries.
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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
599.
Find related papers by JEL classification: E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
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