IDEAS home Printed from https://ideas.repec.org/p/fip/fedgif/272.html
   My bibliography  Save this paper

Expected fiscal policy and the recession of 1982

Author

Listed:
  • William H. Branson
  • Arminio Fraga
  • Robert A. Johnson

Abstract

The Economic Recovery Tax Act of 1981 had one aspect that is unusually useful for economic analysis. It provided an example of a clear-cut announcement of future policy actions at specified dates.This provides an opportunity to apply recent advances in the analysis of expectations dynamics to data that have been generated in an environment that includes such announced and anticipated policy action. A three-stage future tax cut was announced in the Tax Bill in March 1981. In a Keynesian model with liquidity-constrained consumers or investors, or with uncertainity, this would normally be expected to provide a stimulus to the economy when the tax cuts actually appear. But the financial markets could look ahead to the stimulus and the shift in the high-employment deficit brought about by the tax cuts, and their implications for bond prices and interest rates. In this paper we argue that this happened during the first half of 1981. As market participants came to understand that the tax and budget actions of March 1981 implied a future shift of the high-employment -- now "structural" -- deficit by some 5 percent of GNP, they revised their expectations of future real interest rates upward. This caused a jump in real long-term rates then, in 1981. And, it also caused a sudden and unanticipated real appreciation of the dollar at the same time. The jump in real long-term interest rates and the dollar appreciation in the first half of 1981 were essential features of the recession that began in July 1981.This paper points out the possibility of a purely anticipatory recession. If the only policy action had been the fiscal announcement, and if goods markets are "Keynesian" but financial markets are forward-looking, the announcement can cause a recession, which will end when the actual fiscal action begins to stimulate the economy. In the actual context of 1981, a shift toward monetary tightness also contributed to the recession.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • William H. Branson & Arminio Fraga & Robert A. Johnson, 1985. "Expected fiscal policy and the recession of 1982," International Finance Discussion Papers 272, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgif:272
    as

    Download full text from publisher

    File URL: http://www.federalreserve.gov/pubs/ifdp/1985/272/ifdp272.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Wilson, Charles A, 1979. "Anticipated Shocks and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 87(3), pages 639-647, June.
    2. Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
    3. Willem H. Buiter & Marcus Miller, 1991. "Real Exchange Rate Overshooting and the Output Cost of Bringing Down Inflation," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 239-277, National Bureau of Economic Research, Inc.
    4. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-1176, December.
    5. Buiter, Willem H, 1984. "Saddlepoint Problems in Continuous Time Rational Expectations Models: A General Method and Some Macroeconomic Examples," Econometrica, Econometric Society, vol. 52(3), pages 665-680, May.
    6. Willem H. Buiter & Marcus Miller, 1983. "Changing the Rules: Economic Consequences of the Thatcher Regime," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 14(2), pages 305-380.
    7. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-247, April.
    8. R. Dornbusch, 1975. "Exchange Rate Dynamics," Working papers 167, Massachusetts Institute of Technology (MIT), Department of Economics.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Arnold Kling, 1985. "Anticipatory capital flows and the behaviour of the dollar," International Finance Discussion Papers 261, Board of Governors of the Federal Reserve System (U.S.).
    2. repec:hal:spmain:info:hdl:2441/5221 is not listed on IDEAS
    3. Peter Hooper, 1989. "Macroeconomic policies, competitiveness, and U.S. external adjustment," International Finance Discussion Papers 347, Board of Governors of the Federal Reserve System (U.S.).
    4. Vincent Reinhart & Brian Sack, 2000. "The Economic Consequences of Disappearing Government Debt," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(2), pages 163-220.
    5. William H. Branson & Jacob A. Frenkel, 1985. "Causes of Appreciation and Volatility of the Dollar with Comment by Jacob Frenkel," NBER Working Papers 1777, National Bureau of Economic Research, Inc.
    6. repec:spo:wpmain:info:hdl:2441/5221 is not listed on IDEAS
    7. Miller, Marcus & Weller, Paul, 1995. "Stochastic saddlepoint systems Stabilization policy and the stock market," Journal of Economic Dynamics and Control, Elsevier, vol. 19(1-2), pages 279-302.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. van der Ploeg, Frederick, 1993. "Channels of international policy transmission," Journal of International Economics, Elsevier, vol. 34(3-4), pages 245-267, May.
    2. van der Ploeg, F., 1989. "Monetary disinflation, fiscal expansion and the current account in an interdependent world," Other publications TiSEM 484a8e4e-6115-46fb-9a60-b, Tilburg University, School of Economics and Management.
    3. Hany Eldemerdash & Hugh Metcalf & Sara Maioli, 2014. "Twin deficits: new evidence from a developing (oil vs. non-oil) countries’ perspective," Empirical Economics, Springer, vol. 47(3), pages 825-851, November.
    4. Willem H. Buiter & Marcus H. Miller, 1983. "Costs and Benefits of an Anti-Inflationary Policy: Questions and Issues," NBER Working Papers 1252, National Bureau of Economic Research, Inc.
    5. Frenkel, Jacob A. & Mussa, Michael L., 1985. "Asset markets, exchange rates and the balance of payments," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 14, pages 679-747, Elsevier.
    6. Clausen, Volker & Wohltmann, Hans-Werner, 2011. "Oil Price Shocks and Cyclical Dynamics in an Asymmetric Monetary Union," Ruhr Economic Papers 247, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    7. van der Ploeg, F., 1988. "Monetary and fiscal policy in interdependent economies with capital accumulation, death and population growth," Other publications TiSEM 0f2e8d07-235f-4801-8a3b-5, Tilburg University, School of Economics and Management.
    8. repec:zbw:rwirep:0247 is not listed on IDEAS
    9. Grande, G., 1997. "Properties of the Monetary Conditions Index," Papers 324, Banca Italia - Servizio di Studi.
    10. Michael Mussa, 1985. "The Real Exchange Rate as a Tool of Commercial Policy," NBER Working Papers 1577, National Bureau of Economic Research, Inc.
    11. van de Klundert, Theo C N J & van der Ploeg, Frederick, 1987. "Wage Rigidity and Capital Mobility in an Optimizing Model of a Small Open Economy," CEPR Discussion Papers 168, C.E.P.R. Discussion Papers.
    12. Obstfeld, Maurice & Stockman, Alan C., 1985. "Exchange-rate dynamics," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 18, pages 917-977, Elsevier.
    13. Markink & A.J. & Van Der Ploeg.F, 1989. "Dynamic Policy Simulation Of Linear Models With Rational Expectations Of Future Events: A Computer Package," Papers 8906, Tilburg - Center for Economic Research.
    14. Villa Pierre, 1986. "Politique budgétaire est-elle inflationniste (la) ? du nouveau dans un vieux débat ?," CEPREMAP Working Papers (Couverture Orange) 8613, CEPREMAP.
    15. Obstfeld, Maurice & Rogoff, Kenneth, 1984. "Exchange Rate Dynamics with Sluggish Prices under Alternative Price-Adjustment Rules," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(1), pages 159-174, February.
    16. Devereux, Michael & Purvis, Douglas D., 1984. "Fiscal Policy and the Real Exchange Rate Queen's Discussion Paper," Queen's Institute for Economic Research Discussion Papers 275199, Queen's University - Department of Economics.
    17. Wohltmann, Hans-Werner & Clausen, Volker, 2003. "Oil Price Shocks and Monetary Policy in an Asymmetric Monetary Union," Economics Working Papers 2003-11, Christian-Albrechts-University of Kiel, Department of Economics.
    18. Frederick van der Ploeg, 2005. "Back to Keynes?," CESifo Economic Studies, CESifo Group, vol. 51(4), pages 777-822.
    19. Oscar Bajo Rubio, 1998. "Monetary and Fiscal Policies in Dynamic Models of the Open Economy," Documentos de Trabajo - Lan Gaiak Departamento de Economía - Universidad Pública de Navarra 9806, Departamento de Economía - Universidad Pública de Navarra.
    20. Turnovsky, Stephen J., 2011. "On the role of small models in macrodynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 35(9), pages 1605-1613, September.
    21. Chiarella, Carl, 1991. "The bifurcation of probability distributions in a non-linear rational expectations model of monetary economy," European Journal of Political Economy, Elsevier, vol. 7(1), pages 65-78, April.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedgif:272. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Ryan Wolfslayer ; Keisha Fournillier (email available below). General contact details of provider: https://edirc.repec.org/data/frbgvus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.