The Cost of Political Instability: Fiscal Noise and Economic Fluctuations

This paper studies how fiscal noise affects macroeconomic dynamics through the informational content of fiscal policy announcements. We develop a New Keynesian DSGE model in which government spending signals combine credible news with uninformative noise that agents cannot disentangle. In this environment, fiscal noise weakens anticipatory behavior by reducing the perceived credibility of future policy changes. As a result, households optimally adopt a wait-and-see approach, delaying consumption adjustments until implementation. The impact of a restrictive fiscal policy (through a reduction in public spending) is all the greater when the level of noise is high. In other words, the more unstable the political context, the more economic agents will distrust government announcements and underreact to any fiscal austerity measures, thus inducing a strong negative effect on output. Furthermore, the presence of non-Ricardian agents accentuates the recessionary effect of noise.