Trigger Points and Budget Cuts: Explaining the Effects of Fiscal Austerity
NBER Working Paper No. 3844
We propose and solve an optimizing model which explains counterintuitive effects of fiscal policy in terms of expectations. If government spending follows an upward-trending stochastic process which the public believes may fall sharply when it reaches specific "target points," then optimizing consumption behavior and simple budget constraint arithmetic imply a nonlinear relationship between private consumption and government spending. This theoretical relation is consistent with the experience of several countries.
Published: American Economic Review, vol. 83, no. 9, pp. 11-26 March 1993
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