Federal Reserve Bank of Atlanta
FRB Atlanta Working Paper
Fiscal Austerity in Ambiguous Times
This paper analyzes optimal fiscal policy with ambiguity aversion and endogenous government spending. We show that, without ambiguity, optimal surplus-to-output ratios are acyclical and that there is no rationale for either reduction or further accumulation of public debt. In contrast, ambiguity about the cycle can generate optimally policies that resemble "austerity" measures. Optimal policy prescribes higher taxes in adverse times and front-loaded fiscal consolidations that lead to a balanced primary budget in the long-run. This is the case when interest rates are sufficiently responsive to cyclical shocks—that is, when the intertemporal elasticity of substitution is sufficiently low.
Cite this item
Axelle Ferrière & Anastasios G. Karantounias, Fiscal Austerity in Ambiguous Times, Federal Reserve Bank of Atlanta, FRB Atlanta Working Paper 2016-6, 01 Mar 2016, revised 01 Jan 2018.
- D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
- H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
Keywords: public consumption; intertemporal elasticity of substitution; balanced budget; austerity; fiscal consolidation; ambiguity aversion; multiplier preferences
This item with handle RePEc:fip:fedawp:2016-06
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