Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/173158
Authors: 
Lustenhouwer, Joep
Mavromatis, Kostas
Year of Publication: 
2017
Series/Report no.: 
BERG Working Paper Series 130
Abstract: 
We analyze fiscal consolidations using a New-Keynesian model where agents have finite planning horizons and are uncertain about the future state of the economy. Both consumers and firms are infinitely lived, but only plan and form expectations up to a finite number of periods into the future. The length of agents' planning horizons plays an important role in determining how spending cuts or tax increases affect output and inflation. We find that for low degrees of relative risk aversion spending-based consolidations are less costly in terms of output losses, in line with empirical evidence. A stronger response of monetary policy to inflation makes spending-based consolidations more favorable as well. Interestingly, for short planning horizons, our model captures the positive comovement between private consumption and government spending observed in the data.
Subjects: 
Fiscal policy
Finite planning horizons
Bounded rationality
JEL: 
E60
E62
E63
H63
ISBN: 
978-3-943153-51-4
Document Type: 
Working Paper

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