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Should a Government Fiscally Intervene in a Recession and, If So, How?

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  • Harashima, Taiji

Abstract

The validity of discretionary fiscal policy in a recession will differ according to the cause and mechanism of recession. In this paper, discretionary fiscal policy in a recession caused by a fundamental shock that changes the steady state downwards is examined. In such a recession, households need to discontinuously increase consumption to a point on the saddle path to maintain Pareto efficiency. However, they will not “jump” consumption in this manner and instead will choose a “Nash equilibrium of a Pareto inefficient path” because they dislike unsmooth and discontinuous consumption and behave strategically. The paper concludes that increasing government consumption until demand meets the present level of production and maintaining this fiscal policy for a long period is the best option. Consequent government debts can be sustainable even if they become extremely large.

Suggested Citation

  • Harashima, Taiji, 2017. "Should a Government Fiscally Intervene in a Recession and, If So, How?," MPRA Paper 78053, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:78053
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    References listed on IDEAS

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    More about this item

    Keywords

    Discretionary Fiscal policy; Recession; Government consumption; Government debts; Pareto inefficiency; Time preference;
    All these keywords.

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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