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Fiscal Trade‐Offs: The Relationship Between Output and Debt in Policy Interventions

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  • Richard McManus

Abstract

Implicit in fiscal policy debates is that there is a trade‐off between output and debt outcomes; stimulus is at the expense of debt, and austerity at the expense of output. This paper theoretically and empirically investigates this trade‐off through analysing the relationship between traditional output multipliers and ‘debt multipliers’ (the impact of policy on government debt). Theoretically the elasticity between the two is the marginal tax rate from movements of output in response to policy. This leads to two further hypotheses: first, if the marginal tax rate in the private sector is higher than that in the public sector, changes in government spending will result in a larger impact on debt than changes in taxes; and second, ‘fiscal free lunches’ are possible with recent estimates of the output multiplier. Indeed, empirically we find that tax revenues increase from exogenous tax cuts when the response of output is high.

Suggested Citation

  • Richard McManus, 2018. "Fiscal Trade‐Offs: The Relationship Between Output and Debt in Policy Interventions," Manchester School, University of Manchester, vol. 86(S1), pages 50-82, September.
  • Handle: RePEc:bla:manchs:v:86:y:2018:i:s1:p:50-82
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    File URL: https://doi.org/10.1111/manc.12241
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