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Should a Government Fiscally Intervene in a Recession and, If So, How?

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  • Harashima, Taiji

The validity of discretionary fiscal policy in a recession will differ according to the cause and mechanism of recession. In this paper, discretionary fiscal policy in a recession caused by a fundamental shock that changes the steady state downwards is examined. In such a recession, households need to discontinuously increase consumption to a point on the saddle path to maintain Pareto efficiency. However, they will not “jump” consumption in this manner and instead will choose a “Nash equilibrium of a Pareto inefficient path” because they dislike unsmooth and discontinuous consumption and behave strategically. The paper concludes that increasing government consumption until demand meets the present level of production and maintaining this fiscal policy for a long period is the best option. Consequent government debts can be sustainable even if they become extremely large.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 78053.

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Date of creation: 02 Apr 2017
Handle: RePEc:pra:mprapa:78053
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