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Fiscal Policy, Potential Output and the Shifting Goalposts

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  • Fatás, Antonio

Abstract

This paper studies the negative loop created by the interaction between pessimistic estimates of potential output and the effects of fiscal policy during the 2008-2014 period in Europe. The crisis of 2008 created an overly pessimistic view on potential output among policy makers that led to a large adjustment in fiscal policy. Contractionary fiscal policy, via hysteresis effects, caused a reduction in potential output that validated the original pessimistic forecasts and led to a second round of fiscal consolidation. The evidence suggests that this succession of contractionary fiscal policies was likely self-defeating for many European countries as the negative effects on GDP caused more damage to the sustainability of debt than the benefits of the budgetary adjustments. The paper concludes by discussing alternative frameworks for fiscal policy that could potentially avoid this negative loop in future crises.

Suggested Citation

  • Fatás, Antonio, 2018. "Fiscal Policy, Potential Output and the Shifting Goalposts," CEPR Discussion Papers 13149, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:13149
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    4. Philipp Heimberger, 2020. "Potential Output, EU Fiscal Surveillance and the COVID-19 Shock," Intereconomics: Review of European Economic Policy, Springer;ZBW - Leibniz Information Centre for Economics;Centre for European Policy Studies (CEPS), vol. 55(3), pages 167-174, May.
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    6. 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.
    7. 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

    Keywords

    Fiscal policy; Hysteresis; Potential output;
    All these keywords.

    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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