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Fiscal Austerity in Ambiguous Times

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  • Axelle Ferrière
  • Anastasios G. Karantounias

Abstract

This paper analyzes optimal fiscal policy with ambiguity aversion and endogenous government spending. We show that, without ambiguity, optimal surplus-to-output ratios are acyclical and that there is no rationale for either reduction or further accumulation of public debt. In contrast, ambiguity about the cycle can generate optimally policies that resemble \"austerity\" measures. Optimal policy prescribes higher taxes in adverse times and front-loaded fiscal consolidations that lead to a balanced primary budget in the long-run. This is the case when interest rates are sufficiently responsive to cyclical shocks?that is, when the intertemporal elasticity of substitution is sufficiently low.

Suggested Citation

  • Axelle Ferrière & Anastasios G. Karantounias, 2016. "Fiscal Austerity in Ambiguous Times," FRB Atlanta Working Paper 2016-6, Federal Reserve Bank of Atlanta.
  • Handle: RePEc:fip:fedawp:2016-06
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    Cited by:

    1. Steve Raymond & Lukas Schmid & Anastasios Karantounias & Mariano Croce, 2017. "A Tax Plan for Endogenous Innovation," 2017 Meeting Papers 109, Society for Economic Dynamics.
    2. Peter Claeys, 2017. "Uncertainty spillover and policy reactions," Revista ESPE - Ensayos Sobre Política Económica, Banco de la República - ESPE, vol. 35(82), pages 64-77, April.
    3. Anastasios G. Karantounias, 2020. "Model Uncertainty and Policy Design," Policy Hub 2020-17, Federal Reserve Bank of Atlanta.
    4. repec:bdr:ensayo:v:35:y:2017:i:82:p:31-45 is not listed on IDEAS
    5. Anastasios G. Karantounias, 2020. "Doubts about the Model and Optimal Policy," FRB Atlanta Working Paper 2020-12, Federal Reserve Bank of Atlanta.
    6. Saito, Yuta, 2020. "Bequeathing in ambiguous times," MPRA Paper 102718, University Library of Munich, Germany.

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    More about this item

    Keywords

    public consumption; intertemporal elasticity of substitution; balanced budget; austerity; fiscal consolidation; ambiguity aversion; multiplier preferences;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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