Fiscal Crises and Aggregate Demand: Can High Public Debt Reverse the Effects of Fiscal Policy

This paper shows how the power of fiscal policy to affect consumption can vary depending on the level of public debt. At moderate levels of debt fiscal policy has the traditional keynesian effects, Current generations of consumers discount future taxes because they may not be alive when taxes are raised (or there will be a larger population available to pay the taxes). But when debt reaches extreme values, current generations of consumers know there is a high probability that they will have to pay extra taxes. A fiscal deficit can have a contractionary effect in these situations. (C) 1997 Elsevier Science S.A.