Trigger Points and Budget Cuts: Explaining the Effects of Fiscal Austerity
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NBER Working Paper No. 3844
Issued in September 1991
NBER Program(s): EFG
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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