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A Goldilocks Theory of Fiscal Policy

Author

Listed:
  • Atif Mian

    (Princeton University and NBER)

  • Ludwig Straub

    (Harvard University and NBER)

  • Amir Sufi

    (Chicago Booth and NBER)

Abstract

Fiscal policy in advanced economies faces a "Goldilocks dilemma": Fiscal consolidation risks prolonged episodes at the zero lower bound (ZLB), while fiscal expansion raises sustainability concerns. This paper proposes a dynamic fiscal policy framework to study fiscal space subject to this trade-off. At the core of our analysis is a deficit-debt diagram, which we use to measure how much fiscal expansion is necessary to avoid the ZLB, when fiscal policy can run deficits indefinitely, and at what debt level the interest rate rises above the growth rate. Rising inequality and weak aggregate demand expand fiscal space, allowing greater indefinite deficits, while slowing growth tightens the ZLB constraint, requiring greater and greater debt levels. We characterize the effects of various tax policies on fiscal space and provide a cross-country comparison.

Suggested Citation

  • Atif Mian & Ludwig Straub & Amir Sufi, 2021. "A Goldilocks Theory of Fiscal Policy," Working Papers 2021-37, Princeton University. Economics Department..
    • Handle: RePEc:pri:econom:2021-37
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    File URL: https://scholar.harvard.edu/files/straub/files/goldilocks.pdf
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    Cited by:

    1. Yi-Li Chien & Harold L. Cole & Hanno Lustig, 2023. "What about Japan?," NBER Working Papers 31850, National Bureau of Economic Research, Inc.
    2. Carmen M. Reinhart & Franziska L. Ohnsorge & Kenneth S. Rogoff & M. Ayhan Kose, 2022. "The Aftermath of Debt Surges," Annual Review of Economics, Annual Reviews, vol. 14(1), pages 637-663, August.
    3. Pierre Olivier Gourinchas, 2023. "International Macroeconomics: From the Great Financial Crisis to COVID-19, and Beyond," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 71(1), pages 1-34, March.

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    More about this item

    Keywords

    fiscal policy; Goldilocks dilemma;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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