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Fighting deflation with unconventional fiscal policy

D’Acunto, Francesco, Hoang, Daniel, Weber, Michael, (2016), “Fighting deflation with unconventional fiscal policy”, VoxEu, 26 Απριλίου

The Eurozone faces zero inflation paired with low economic growth. With monetary policy hobbled by the zero lower bound, it is time to think more broadly. This column discusses the theoretical and empirical evidence on ‘unconventional fiscal policy’.  Such policies aim to increase growth and inflation in a budget-neutral fashion, while keeping the tax burden on households constant. Discretionary fiscal policy is often rejected as a tool for business cycle stabilisation. It is less desirable than conventional monetary policy because of implementation lags, larger permanent deficits resulting in higher long-term interest rates and distortionary future taxes, and higher marginal propensities to save out of a temporary tax cut (i.e. lower (old) Keynesian multipliers). At the same time, fiscal policy might stimulate demand at times when conventional monetary policy is not viable. Feldstein (2003) stresses that discretionary fiscal policy does not need to rely on questionable income effects, but could fully operate through an inter-temporal substitution channel by increasing private incentives to spend. Higher inflation expectations lead to higher consumer spending today. Unconventional fiscal policy can be expansionary and, at the same time, avoid budget deficits.

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