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 |
| JEL(s): | E21, E62 |
| 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.