DP1246 Fiscal Crises and Aggregate Demand: Can High Public Debt Reverse the Effects of Fiscal Policy?

Author(s): Alan Sutherland
Publication Date: September 1995
Keyword(s): Aggregate Demand, Fiscal Policy, Public Debt Stabilization
JEL(s): E21, E62, H69
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1246

This paper shows how the power of fiscal policy to affect consumption can vary depending on the level of public debt. At moderate levels of debt fiscal policy has the traditional Keynesian effects. Current generations of consumers discount future taxes because they may not be alive when taxes are raised (or there will be a larger population available to pay the taxes). But when debt reaches extreme values, current generations of consumers know there is a high probability that they will have to pay extra taxes. An increase in the fiscal deficit has a contractionary effect in these situations.