Fiscal Austerity in Ambiguous Times

60 Pages Posted: 25 Mar 2016 Last revised: 19 Jan 2018

See all articles by Axelle Ferriere

Axelle Ferriere

European University Institute

Anastasios G. Karantounias

Federal Reserve Banks - Federal Reserve Bank of Atlanta

Multiple version iconThere are 2 versions of this paper

Date Written: August 15, 2017

Abstract

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.

Keywords: public consumption, intertemporal elasticity of substitution, balanced budget, austerity, fiscal consolidation, ambiguity aversion, multiplier preferences

JEL Classification: D80, E62, H21, H63

Suggested Citation

Ferriere, Axelle and Karantounias, Anastasios G., Fiscal Austerity in Ambiguous Times (August 15, 2017). Available at SSRN: https://ssrn.com/abstract=2753866 or http://dx.doi.org/10.2139/ssrn.2753866

Axelle Ferriere

European University Institute ( email )

Via delle Fontanelle 18
Villa La Fonte
Fiesole, 50014
Italy

Anastasios G. Karantounias (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States

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