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Working Paper
Debt and the effects of fiscal policy
A fiscal shock due to a shift in taxes or in government spending will, at some point in time, constrain the future path of taxes and spending, since the government?s intertemporal budget constraint will eventually have to be met. This simple fact is surprisingly overlooked in analyses of the effects of fiscal policy based on vector autoregressive models. We study the effects of fiscal shocks, keeping track of the debt dynamics that arise following a fiscal shock and allowing for the possibility that taxes, spending, and interest rates might respond to the level of the debt as it evolves over ...