This paper examines the effects of heterogeneous biased expectations between the young and old on business cycles and explores its policy implications. Empirical findings reveal that individuals, particularly the young, can have more optimistic or pessimistic views about the future state of the economy compared to the data-generating measure. This study relates these results to the learning-from-experience literature, which suggests that individuals, particularly the young, place greater weight on recent observations when forming their expectations. Incorporating household weighting schemes into a life-cycle learning model, I show that household sensitivity to recent observations amplifies the effects of economic shocks. However, the amplification effects become less extensive as the population ages due to the lower sensitivity of the old. My simulation results indicate that a 10 percentage point increase in the old population ratio leads to a 16 percent decrease in output volatility. Regarding policy implications, this paper suggests that the government spending multiplier declines by approximately 10 percent when the old population ratio rises by 10 percentage points due to weak amplification effects. Moreover, the weakened output effects deteriorate the welfare of the population, particularly that of the young.

This study investigates the effect of government size, as measured by the tax revenue to gross domestic product (tax-GDP) ratio, on output responses to increases in government purchases. First, we show that in a standard static neoclassical model, the stimulus effect of fiscal expansion on output increases with the tax-GDP ratio. This finding is quantitatively confirmed using a dynamic neoclassical model with standard functional forms and parameter values. To empirically test the theoretical findings, we analyze the responses of macroeconomic variables to an unanticipated increase in government purchases for 12 Organisation for Economic Cooperation and Development (OECD) countries during 1985–2019 using a state-dependent local projection method. The estimation results reveal that while output responses to an unanticipated fiscal expansion are significantly positive when the tax-GDP ratio is high, they are statistically indistinguishable from zero when the ratio is low. Overall, our findings suggest that fiscal expansion can stimulate output more effectively at high tax rates, unlike the well-known predictions of the traditional Keynesian model.

Monetary policy in the USA affects borrowing costs for state and local governments, incentivizing municipal borrowing and spending, which in turn affects economic outcomes. Using municipal bond indices and transaction-level data, I find that responses to monetary policy are dampened relative to treasuries and heterogeneous across location and bond characteristics. In my baseline estimate, muni yields move 26 bp after a 100 bp monetary shock. To study implications for local fiscal policy, I model US localities as small open economies in a monetary union with independent fiscal agents. In a calibrated model, monetary transmission is significantly affected by municipal borrowing costs.

Motivated by the sharp increases in public spending following the global financial crisis, we employ the GMM Panel VAR approach at annual frequency between 2004 and 2014 to investigate the dynamic response of alternative income distribution variables to shocks imposed on tax revenues and three key components of social expenditures: social protection, health, and education. We confirm the potential of fiscal policy to reduce income inequality in the medium to longer run, but point to the differential approaches to pursue such a goal in middle- versus high-income countries. We find that the particular expenditure component under consideration matters in terms of the dynamic effect on inequality and on different parts of the income distribution, as well as in terms of the implied time profile. In middle-income countries, positive education spending shocks are the most effective in achieving better distributional outcomes over a medium run of several years. By contrast, in high-income countries, positive health spending and tax shocks have a more pronounced favorable dynamic distributional effect.

We show that trade credit contracts between sectors can provide a useful alternative to fiscal transfers during a major productivity shock. Defaults in credit contracts function as transfers between sectors, which can be implemented through a bankruptcy law or through credit renegotiation. Transfers implemented through defaults allow for a reduction in the size of the fiscal policy that restores the economy to the optimal allocation, constituting a relevant alternative to economies without an available fiscal space to implement the optimal policy.

Sustainable finance is often discussed as a solution to the climate crisis, but its impacts are limited and its discourse focuses on mobilising private investments through public de-risking, without considering direct government action. We argue that this is due to an implicit reference to mainstream economic theory assuming that an active state leads to time inconsistency problems and crowding-out effects. However, these assumptions have been sufficiently refuted as public investments may actually crowd-in private capital. We therefore propose a paradigm shift towards what we call Public Sustainable Finance, aimed at empowering the role of the state in the green transition on the discursive, policy, and political economy levels. Studying the case of Germany, we show how Public Sustainable Finance can be introduced despite tight fiscal regimes. To this end, we propose that the Climate- and Transformation Fund be given its own borrowing powers. By borrowing an average of 23 billion euros annually from 2024 to 2030, the existing financing gap that has been exacerbated following the November 2023 constitutional court ruling can be closed, enabling a more rapid and effective green transition.

The public places an important constraint on funding security in Europe, and austerity risks making the constraint tighter. Several recent studies show that curtailing military spending is a popular way to reduce debt in Europe. Yet it remains unclear if military spending aversion persists when threats are salient. We fielded an original survey experiment in Italy weeks before the Russian invasion of Ukraine to examine how information about security threats influences military spending preferences and fiscal trade-offs. We found that information about threats increases support for military spending. To validate the survey experiment, we recontacted and remeasured our respondent's preferences three weeks after Russia's invasion and find evidence consistent with our initial experiment. Our findings suggest that, while public opposition to military spending remains high in Italy, external threats dampen the public's opposition to military spending, even under high debt burdens.

In 1923, Los Angeles teachers protested the state’s biennial budget, a controversial document from newly elected governor Friend Richardson that significantly cut funding to government agencies. The budget was the culmination of more than a decade of fiscal policy reform that reflected a significant shift in anti-tax sentiment. The expansion of state governance in the early twentieth century required the development of fiscal policies to meet the needs of the modern state, and public debates about taxation reflected deep ideological differences about the structure and scope of government and implicated public schooling. This analysis demonstrates two features of fiscal policy reform in California. First, tax reform shaped and was shaped by the political context, demonstrating the dynamic relationship between fiscal policy and state formation. Second, debates about tax reform were ultimately about the scope of government. Anti-tax campaigns that sought a more limited government implicated schooling, the largest item in the state budget, and undermined efforts to achieve educational equity.

Over the past decade, the most salient changes in macroeconomic conditions in developed economies have included rising government debt and population aging, which are strongly correlated with each other. This paper investigates fiscal multipliers by disentangling the effects of population aging from those of government debt. Our analysis, which uses heterogeneous panel data from 24 OECD economies, shows that while fiscal policy is ineffective for economies with high-debt levels, it is effective for economies with low-debt levels. Furthermore, the estimation results reveal that fiscal policy is ineffective for aged economies, regardless of the level of government debt. However, for nonaged economies, while fiscal policy leads to negative effects on output in times of high debt, its positive effects are more pronounced in times of low debt. Our results suggest that, for the effective implementation of fiscal stimulus policies, policy-based stimulation of employment in the labor market is essential.

What explains the variation in countries’ propensity to engage in austerity policy? Economic and political country-level factors are the paramount explanations in the literature. Nevertheless, variation in fiscal preferences at the executive level remains underexplored, except for ideology. Moreover, budget decisions are endogenous to the state of the economy, thus casting doubt on standard measures based on the debt and/or deficit ratio. This article contributes to the literature in two ways. First, I turn to the individual level of analysis and suggest that leaders with business experience are more likely to pursue a balanced budget and tend to implement fiscal consolidation policies based on spending cuts. Second, I ease concerns about individuals’ self-selection into office by relying on fiscal adjustments that are weakly orthogonal to the economic cycle. The statistical analysis of a panel of 17 OECD countries between 1978 and 2014 confirms the theoretical expectations. The results are robust to a variety of specification and statistical methodologies and hold for a subset of as-if random leadership transitions following close elections. A case study of Brian Mulroney's governments in Canada (1984–93) further illustrates the argument.

In recent decades, governments in many Western democracies have shown a remarkable consensus in pursuing fiscal austerity measures during periods of strained public finances. In this article, we show that these decisions have consequences for political polarization. Our macro-level analysis of 166 elections since 1980 finds that austerity measures increase both electoral abstention and votes for non-mainstream parties, thereby boosting party system polarization. A detailed analysis of selected austerity episodes also shows that new, small and radical parties benefit most from austerity policies. Finally, survey experiments with a total of 8,800 respondents in Germany, Portugal, Spain and the UK indicate that the effects of austerity on polarization are particularly pronounced when the mainstream right and left parties both stand for fiscal restraint. Austerity is a substantial cause of political polarization and hence political instability in industrialized democracies.