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Trigger Points and Budget Cuts: Explaining the Effects of Fiscal Austerity

Author

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  • Bertola, Giuseppe
  • Drazen, Allan

Abstract

We present and analyse an optimizing model which explains the counter-intuitive effects of fiscal policy in terms of expectations. If government spending follows an upward-trending stochastic process, which the public believes may fall sharply when it reaches specific `target points', then optimizing consumption behaviour and simple budget constraint arithmetic imply a non-linear relationship between private consumption and government spending. This theoretical relation is consistent with the experience of several countries.

Suggested Citation

  • Bertola, Giuseppe & Drazen, Allan, 1991. "Trigger Points and Budget Cuts: Explaining the Effects of Fiscal Austerity," CEPR Discussion Papers 599, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:599
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    Keywords

    Consumption Smoothing; Stabilization; Sustainability;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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