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Original Articles

Does an active fiscal policy work under a high level of government debt?

Pages 1083-1088 | Published online: 28 Jan 2015
 

Abstract

This article theoretically investigates the effect of expansionary fiscal shocks when the government faces a high debt-to-GDP ratio, under the regime of an active fiscal policy with a passive monetary policy in the terminology of Leeper (1991). We find that expansionary fiscal shocks become less effective when the government faces a high level of debt because the wealth effect on households decreases.

JEL Classification:

Notes

1 We abstract other shocks such as technology and monetary shocks to focus on the effect of fiscal shocks.

2 In a Ricardian economy, Equation 8 implies a restriction on fiscal policy that is necessary and sufficient to sustain zero inflation in the steady state. In contrast, in a non-Ricardian economy, the present value of the net-of-interest government surplus is preset, and hence the price level and, in turn, inflation are determined.

3 This finding is consistent with Kim (Citation2004).

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