Fiscal Austerity in Ambiguous Times

60 Pages Posted: 4 Apr 2016 Last revised: 29 Apr 2020

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: 2016-03-01


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 (2016-03-01). FRB Atlanta Working Paper No. 2016-6, Available at SSRN:

Axelle Ferriere (Contact Author)

European University Institute ( email )

Via delle Fontanelle 18
Villa La Fonte
Fiesole, 50014

Anastasios G. Karantounias

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

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

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