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.