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Dynamic adjustment of fiscal policy under a debt crisis

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  • Dioikitopoulos, Evangelos V.

Abstract

In an overlapping generations framework that allows for the presence of a debt crisis scenario (debt bubbles), we introduce productive government expenditures, and endogenous deficits through a dynamic fiscal rule that combines fiscal stimulus and fiscal consolidation. We formally argue that a fiscal rule must be pro-cyclical to output for government investment financing and simultaneously has to control for the level of debt adjusting taxation for a policy aiming to escape a situation of exploding debt and low economic activity. Then, when the economy becomes sustainable (or in an economy’s high initial private capital), the same rule, has to endogenously adapt to the actual level of debt and income in order to stimulate private investment through lower taxes. We provide a numerical example for our theoretical results and show that in economies with sufficiently low levels of capital and high levels of debt, the tax rate has to adjust non-monotonically during the recover process, reflecting the two counter-balancing properties of the examined fiscal policy rule. However, under a threshold level of initial capital stock, taxes must adjust monotonically (negatively) to boost private investment activity, and in turn, alleviating the volume of debt though a higher tax base.

Suggested Citation

  • Dioikitopoulos, Evangelos V., 2018. "Dynamic adjustment of fiscal policy under a debt crisis," Journal of Economic Dynamics and Control, Elsevier, vol. 93(C), pages 260-276.
  • Handle: RePEc:eee:dyncon:v:93:y:2018:i:c:p:260-276
    DOI: 10.1016/j.jedc.2018.01.032
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    Cited by:

    1. Lorenzo Cerboni Baiardi & Ahmad Naimzada, 2020. "Existence, multiplicity and policy prescriptions for debt sustainability in an OLG model with fiscal policy and debt," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 43(2), pages 769-786, December.
    2. Lorenzo Cerboni Baiardi & Ahmad Naimzada, 0. "Existence, multiplicity and policy prescriptions for debt sustainability in an OLG model with fiscal policy and debt," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 0, pages 1-18.
    3. Lorenzo, Cerboni Baiardi & Ahmad, Naimzada, 2018. "Existence, multiplicity and dynamic complexity in an OLG model with fiscal policy and debt," Working Papers 385, University of Milano-Bicocca, Department of Economics, revised 28 Jul 2018.

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    More about this item

    Keywords

    Fiscal sustainability; Fiscal rules; Bond-financed deficits;
    All these keywords.

    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H6 - Public Economics - - National Budget, Deficit, and Debt
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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