Fiscal Policy and Uncertainty

Abstract

Government fiscal aggregates are often manipulated over the course of the business cycle in order to provide counter–cyclical stimulus. Changes that are not discretionary – the so–called ‘built–in stabilizers’– also significantly vary over the business cycle, in a manner that is even more predicatable than the periodic discretionary measures.Such measures introduce important bi–directional interactions between policy and uncertainty. On the one hand, activist policy may heighten the general level of uncertainty in the economy, by adding policy ambiguity to the more fundamental sources of uncertainty. On the other hand, the design of optimal policy itself depends crucially on levels of uncertainty concerning the state of the economy in the short and long run. In this paper we review recent work that explores the impact of uncertainty on optimal policy design, proceeding from the short to the long run.