Friday, Jan. 5, 2018 8:00 AM - 10:00 AM
- Chair: Javier Bianchi, Federal Reserve Bank of Minneapolis
The Role of Countercyclical Fiscal Policy in a Low r* World
AbstractIf the natural rate of interest is lower in the future, discretionary fiscal policy may come with larger multipliers. But this does not imply that countercyclical fiscal policy should be more active, or that there should be a larger role for automatic stabilizers. This paper investigates if this is so by solving a business cycle model with heterogeneous agents and nominal rigidities, which frequently hits the zero lower bound. If markets are complete, then fiscal policy should be more active at the zero lower bound only if its precision is large enough. If markets are incomplete, there may be a tradeoff between more active policy or more aggressive automatic stabilizers. We quantify these effects in a model calibrated to the U.S. economy.
Time-consistent Fiscal Policy in a Debt Crisis
AbstractWe analyze time-consistent fiscal policy in a sovereign debt model. We consider a production economy and assume one-sided lack of commitment. We extend the literature by considering both an intertemporal insurance channel (against productivity shocks) and intratemporal insurance (against unemployment). Households search for jobs and, if they find employment, pay a proportional income tax. If unemployed, households receive unemployment benefits. Firms hire workers in a frictional matching market by posting vacancies. The government sets income taxes, unemployment benefits, provide a public good, and can borrow on international markets as long as they have have not defaulted. If a government defaults, it loses access to international lending temporarily and may also suffer a drop in productivity. We assume that the government cannot commit to any of its instruments. A government with access to international financial markets sets procyclical taxes, transfers and public goods provision in good times. When the economy experiences a series of bad productivity shocks, default premia start rising. In crisis times, which we define as periods when default premia respond elastically to debt issuance, the government implements austerity by cutting back aggressively on welfare benefits and hiking tax rates. The reason is that the government has an incentive to default and stimulate the economy which makes lenders willing to supply funds unless the government uses austerity as a partial commitment device. If a third party could credibly prevent a post-default fiscal stimulus by for example imposing fiscal rules that are not void in case of default, austerity is no longer optimal. We show that the model is consistent with important features of the Greek debt crisis.
Fiscal Policy, Sovereign Risk and Unemployment
AbstractWhat is the optimal fiscal policy during a sovereign debt crisis? We address this question using a sovereign default model with downward wage rigidity. An increase in government spending during a recession stimulates economic activity and reduces unemployment. Because the government lacks commitment to future debt repayments, expansionary fiscal policy increases sovereign spreads making the fiscal stimulus less desirable. We analyze the optimal fiscal policy and study quantitatively whether austerity or stimulus is optimal during an economic slump.
Federal Reserve Bank of New York
University of Oregon
University of Minnesota
University of Pennsylvania
- E3 - Prices, Business Fluctuations, and Cycles
- F3 - International Finance