Fiscal Policies in Booms and Busts

Paul De Grauwe, Yuemei Ji and Pasquale Foresti

No 13740, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We introduce fiscal policies into a behavioral macroeconomic model. We show how animal spirits play an important role in the dynamics of the business cycle and of public debt. These animal spirits are able to generate different sizes of fiscal multipliers depending on the state of the economy. Depending on the interest rate regime (high or low), they affect the capacity of fiscal authorities to stabilize the economy. In the high interest rate regime the fiscal authorities face a steep trade-off between output stabilization and the stabilization of public debt, i.e. attempts to stabilize the business cycle quickly hit a limitation of debt sustainability. In the low interest rate regime, when the steady state interest rate is lower than the growth rate of the economy, the use of fiscal policy as a tool of output stabilization is made considerably stronger.

Keywords: Fiscal policy; Public debt sustainability; Fiscal multiplier; Low and high interest rate regimes; Tradeoffs (search for similar items in EconPapers)
Date: 2019-05
New Economics Papers: this item is included in nep-mac and nep-pub
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Citations: View citations in EconPapers (2)

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