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.
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).