DP599 Trigger Points and Budget Cuts: Explaining the Effects of Fiscal Austerity
|Author(s):||Giuseppe Bertola, Allan Drazen|
|Publication Date:||December 1991|
|Keyword(s):||Consumption Smoothing, Stabilization, Sustainability|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=599|
We present and analyse an optimizing model which explains the counter-intuitive effects of fiscal policy in terms of expectations. If government spending follows an upward-trending stochastic process, which the public believes may fall sharply when it reaches specific `target points', then optimizing consumption behaviour and simple budget constraint arithmetic imply a non-linear relationship between private consumption and government spending. This theoretical relation is consistent with the experience of several countries.