Trigger Points and Budget Cuts: Explaining the Effects of Fiscal Austerity

Abstract

The authors propose and solve an optimizing model that explains counterintuitive effects of fiscal policy in terms of expectations. If government spending follows an upward-trending stochastic process that the public believes may fall sharply when it reaches specific "trigger" points, then optimizing consumption behavior and simple budget-constraint arithmetic imply a nonlinear relationship between private consumption and government spending. Th is theoretical relation is consistent with the experience of several countries. Copyright 1993 by American Economic Association.

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