Fiscal multipliers, public debt anchor and government credibility in a behavioural macroeconomic model

Abstract

We develop a behavioural macroeconomic model to investigate the question of fiscal policy credibility and how agents’ expectations about the output gap, public debt, expenditure and taxation affect the fiscal multiplier and debt stability. To do this, we model heterogeneous expectation-formation processes in a market populated by fundamentalists and chartists, agents being able to switch from one rule to another depending on the effective outcome in each period. This model produces waves of optimism and pessimism along the business cycle. We show in this article that when agents are optimistic about the future output gap and public debt, the fiscal multiplier tends to be larger whatever the nature of the fiscal shock. It also appears that fiscal expansion has less of a negative effect on public debt. Furthermore, agents’ expectations about public debt and the fiscal credibility of the government affect indicators of government performance (the fiscal multiplier and public debt stability).