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Deficits, public debt dynamics, and tax and spending multipliers
Cutting government spending on goods and services increases the budget deficit if the nominal interest rate is close to zero. This is the message of a simple but standard New Keynesian DSGE model calibrated with Bayesian methods. The cut in spending reduces output and thus?holding rates for labor and sales taxes constant?reduces revenues by even more than what is saved by the spending cut. Similarly, increasing sales taxes can increase the budget deficit rather than reduce it. Both results suggest limitations of ?austerity measures? in low interest rate economies to cut budget deficits. ...