Abstract
Macroeconomic crises are common as well as economically, socially and politically costly. Fiscal policy plays an important role in alleviating the costs of the crisis. However, recent experiences suggest that the public finances are often unprepared for a crisis. Deficits and debt levels prior to the crisis are commonly too high, limiting the government’s ability to support the economy through the crisis and the recovery phase. In this article, I argue that theoretical macroeconomic models’ underlying assumption of a stable long-run equilibrium may partially explain why governments fail to prepare the public finances for a future crisis. In the standard equilibrium models, crises are seen as one-off events caused by external factors, which creates a false impression of long-run economic stability. The models thus indirectly indicate that there is no need to prepare for a potential crisis. Using forecast data, I demonstrate how the equilibrium perspective dominates macroeconomic thinking and how it contributes to too-high debt ratios prior to a crisis. I end the article by discussing how to design fiscal policy rules based on a crisis rather than an equilibrium perspective.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Disclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.