Fiscal Policy and Economic Perspectives: An Assessment of the Transitional and Steady State Effects

Abstract

The dynamic effects of fiscal policy in terms of budget deficits and the concomitant implications of public debt have been the dominant issues in macroeconomic literature. Of particular concern is the choice of the life horizon (finite or infinite) of economic agents, since it remains crucial for the characterisation of the transition process towards the steady state of the economy. This paper develops a simple equilibrium model suitable to examine such issues. The first part analyses the solvency constraint of the private sector, in the presence of a government, by focusing on the dynamic behaviour of savings, consumption and asset allocation. The second part explores the steady-state effects of fiscal policy, by clarifying the role of government spending and public debt in determining interest rates. A modified index of fiscal stance is then derived that embraces the effects of current and anticipated fiscal policy, including the effects of government finance, on aggregate demand.

Keywords: Fiscal Policy, Private-Sector Asset Allocation, Interest Rates, Transitional Dynamics, Steady State Effects, Public Debt

JEL Classification: E2, H3, H6