How Does Uncertainty About Future Fiscal Policy Affect Current Macroeconomic Variables?
A macromodel is constructed based on risk-averse, dynamically-optimising, wage-setting households. The money is set one period in advance, so that randomness in future fiscal policy causes randomness in future output. The mechanism is through increasing the demand for money and thence the current interest rate. We suggest that such fiscal uncertainty is one possible cause of the current faltering of the economic recovery in Europe.
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