Fiscal Consolidation As a Self-Fulfilling Prophecy on Fiscal Multipliers

Abstract

Fiscal policy may affect the size of the fiscal multiplier or lengthen the elevated multipliers period. This notion at first seems controversial, however it is only an outcome of combining two strands of already available literature together. The first strand touches the effects of fiscal policy on economic situation, the second one suggests economic situation affects fiscal multiplier. Having those two premises implies that fiscal policy could indirectly influence the fiscal multiplier size or the length of the elevated multiplier period. This possibility is fitted into a simple model of liquidity trap with hysteresis effects. One of the main outcomes of the model is that, when the government expectations on the size of the fiscal multiplier influence fiscal actions - as it is possibly the case - those expectations may become selffulfilling prophecies.