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Austerity versus Stimulus: A DSGE Political Economy Explanation


  • Richard McManus


The 2008 financial crisis and subsequent global economic downturn has brought fiscal policy back onto the political and academic agenda. Despite the vast literature, the discussion is primarily focused upon the fiscal policy multiplier. This positive analysis omits normative consequences from policy and moreover, fails to consider political frictions to policy: something frequently observed in fiscal debates. By constructing a small scale New Keynesian DSGE model with a proportion of credit constrained (non-Ricardian) agents, this paper address these omissions. The results show that there is a normative justification of fiscal policy, in the presence of modest multipliers and the absence of progressive taxes, but on redistributive rather than aggregate grounds. Shocks impact the two agents differently and in polarising ways: countercyclical fiscal policy can be used to alleviate this divergence. However, aggregate improvements from policy are minimal as the gains of one agent are matched by the losses of another, thus giving rise to political frictions and moreover, predicting the current austerity versus stimulus debate.

Suggested Citation

  • Richard McManus, 2013. "Austerity versus Stimulus: A DSGE Political Economy Explanation," Discussion Papers 13/09, Department of Economics, University of York.
  • Handle: RePEc:yor:yorken:13/09

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    More about this item


    Fiscal policy; heterogeneity; welfare; zero lower bound; liquidity rule-of-thumb; fiscal cyclicality;

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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