Title

A Goldilocks Theory of Fiscal Policy

Author(s)

Atif Mian Atif Mian (Princeton University and NBER)

Ludwig Straub Ludwig Straub (Harvard University and NBER)

Amir Sufi Amir Sufi (Chicago Booth and NBER)

Abstract

Fiscal policy in advanced economies faces a "Goldilocks dilemma": Fiscal consolidation risks prolonged episodes at the zero lower bound (ZLB), while fiscal expansion raises sustainability concerns. This paper proposes a dynamic fiscal policy framework to study fiscal space subject to this trade-off. At the core of our analysis is a deficit-debt diagram, which we use to measure how much fiscal expansion is necessary to avoid the ZLB, when fiscal policy can run deficits indefinitely, and at what debt level the interest rate rises above the growth rate. Rising inequality and weak aggregate demand expand fiscal space, allowing greater indefinite deficits, while slowing growth tightens the ZLB constraint, requiring greater and greater debt levels. We characterize the effects of various tax policies on fiscal space and provide a cross-country comparison.

Creation Date

2021-07

Section URL ID

Paper Number

2021-37

URL

https://scholar.harvard.edu/files/straub/files/goldilocks.pdf

File Function

Jel

E62

Keyword(s)

fiscal policy, "Goldilocks dilemma"

Suppress

false

Series

13