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Fiscal sentiment and the weak recovery from the Great Recession: a quantitative exploration

  • Finn E. Kydland
  • Carlos E. Zarazaga

The U.S. economy isn' t recovering from the deep Great Recession of 2008–2009 with the strength predicted by models that incorporate a variety of shocks and frictions in the basic analytical framework of the neoclassical growth model. It has been argued that the counterfactual predictions shouldn 't be attributed to inherent features of that framework, but to the omission from the analysis of the prospects of an imminent switch to a higher taxes regime prompted by the unprecedented fiscal challenges faced by the U.S. economy in peacetime. The paper explores quantitatively this fiscal sentiment hypothesis. The main finding is that the hypothesis can account for a substantial fraction of the decline in investment and labor input in the aftermath of the Great Recession, relative to their pre-recession trends. These results require, however, a quali cation: The perceived higher taxes must fall almost exclusively on capital income.

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Paper provided by Federal Reserve Bank of Dallas in its series Working Papers with number 1301.

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Date of creation: 2013
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Handle: RePEc:fip:feddwp:1301
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