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Deficits, Public Debt Dynamics, and Tax and Spending Multipliers
Revised: September 2012
JEL classification: E52, E62
Gauti B. Eggertsson, and
Cutting government spending can increase the budget deficit at zero interest rates according to a standard New Keynesian model, calibrated with Bayesian methods. Similarly, increasing sales taxes can increase the budget deficit rather than reduce it. Both results suggest limitations of “austerity measures.” At zero interest rates, running budget deficits can be either expansionary or contractionary depending on how they interact with expectations about long-run taxes and spending. The effect of fiscal policy action is thus highly dependent on the policy regime. A successful stimulus, therefore, needs to specify how the budget is managed, not only in the short but also in the medium and long runs.
For a published version of this report, see Matthew Denes, Gauti B. Eggertsson, and Sophia Gilbukh, "Deficits, Public Debt Dynamics and Tax and Spending Multipliers," The Economic Journal 123, no. 566 (February 2013): F133-63.