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Fiscal Policy, Potential Output, and the Shifting Goalposts

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  • Antonio Fatás

    (INSEAD, CEPR, and ABFER)

Abstract

This paper studies the negative loop caused by the interaction between pessimistic estimates of potential output and the effects of fiscal policy in Europe during 2008–2014. We argue that policymakers’ reliance on overly pessimistic views of potential output led to a large adjustment in fiscal policy. Contractionary fiscal policy, via hysteresis effects, caused a reduction in potential output that in part validated the original pessimistic forecasts and led to a second round of fiscal consolidation. The paper concludes by discussing alternative frameworks for fiscal policy that could avoid this negative loop in future crises.

Suggested Citation

  • Antonio Fatás, 2019. "Fiscal Policy, Potential Output, and the Shifting Goalposts," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 67(3), pages 684-702, September.
    • Handle: RePEc:pal:imfecr:v:67:y:2019:i:3:d:10.1057_s41308-019-00087-z
    DOI: 10.1057/s41308-019-00087-z
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    Cited by:

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    3. Daniele Tavani & Luke Petach, 2021. "Firm beliefs and long-run demand effects in a labor-constrained model of growth and distribution," Journal of Evolutionary Economics, Springer, vol. 31(2), pages 353-377, April.
    4. Luke Petach & Daniele Tavani, 2021. "Aggregate Demand Externalities, Income Distribution, and Wealth Inequality," FMM Working Paper 66-2021, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
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    More about this item

    JEL classification:

    • 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

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