Economic Policy Visualization

Policy · Themes

Dr. Matthias Schnetzer

December 1, 2025

Fiscal policy

Neoclassical critique of fiscal policy

  • Ricardian Equivalence: government spending does not change aggregate demand, as households anticipate that they will pay expenditure as future taxes.
  • Crowding out: when governments borrow money, it affects interest rates through the loanable funds market, depressing investment spending and encouraging saving.
  • Political pressure: since fiscal policy is done by the government, it needs political support, which may vary from what’s actually best for the economy

Keynesian legitimation for fiscal policy

  • Aggregate demand determines economic growth
  • Lack of aggregate demand and involuntary unemployment persist
  • Fiscal policy is essential to reduce economic volatility
  • Fiscal policy should be anti-cyclical
  • No balanced budget required in the short term
  • Public investment increases aggregate demand with multiplier

The fiscal multiplier

\[ Y = C(\theta) + I(r) + G + NX \]

\[ C = \alpha_0 + \alpha_1 (1 - \theta) Y \]

\[ Y - \alpha_1(1-\theta)Y = \alpha_0 + I(r) + G + NX \]

\[ \frac{\partial Y}{\partial G} = \frac{1}{(1 - \alpha_1 + \alpha_1 \theta)} \]

\[ \alpha_1 \in (0, 1); \; \theta \in (0, 1); \; \frac{\partial Y}{\partial G} > 1 \]

Second-round effects

\[ \alpha_1 = 0.6; \; \theta = 0.3; \]

Total multiplier: \[ Y^* = 1/(1 - 0.6 + 0.6 \cdot 0.3) \simeq 1.7 \]

First round: \[ \alpha_1 (1-\theta)\Delta Y = 0.6 \cdot (1-0.3) \cdot 1 \simeq 0.4 \]

Second round: \[ 0.6 \cdot (1-0.3) \cdot 0.4 \simeq 0.2 \]

Keynes Cross

Keynes Cross

Keynes Cross

Government expenditure in Austria, 2024

Sectoral balances (net lending/net borrowing)

Effects of fiscal consolidation on distribution

Studies typically find that inequality increases in periods of fiscal consolidation (with similar data):

  • Ball et al. (2013): 17 OECD countries from 1978 to 2009
  • Agnello/Sousa (2014): 18 industrialized countries from 1978 to 2009
  • Woo et al. (2016): 17 OECD countries from 1980 to 2010
  • Heimberger (2020): 17 OECD countries from 1978 to 2013

Data on fiscal consolidation is provided by Devries et al. (2011): “A New Action-based Dataset of Fiscal Consolidation”. Narrative approach that focuses on policy actions (tax hikes and/or spending cuts) taken by governments with the intent of reducing the budget deficit.

Methodology: Impulse response functions (IRF) from local projections as proposed by Jordà (2005).

Consolidation episodes

Country Epidodes Country Epidodes
🇦🇺 1985–1988, 1994–1999 🇮🇹 1991–1998, 2004–2007, 2010–2013
🇦🇹 1980–1981, 1984, 1996–1997, 2001–2002, 2011–2013 🇯🇵 1979–1983, 1997–1998, 2003–2007
🇧🇪 1982–1985, 1987, 1990, 1992–1994, 1996–1997, 2010–2013 🇳🇱 1981–1988, 1991–1993, 2004–2005
🇨🇦 1984–1997 🇵🇹 1983, 2000, 2002, 2005–2007, 2010–2013
🇩🇰 1983–1986, 1995, 2011–2013 🇪🇸 1983–1984, 1989, 1992–1997, 2009–2013
🇫🇮 1992–1997 🇸🇪 1984, 1993–1998
🇫🇷 1979, 1987, 1991, 1995–1997, 2011–2013 🇬🇧 1979–1982, 1994–1999, 2010–2013
🇩🇪 1982–1984, 1991–1995, 1997, 1999–2000, 2003–2004, 2006–2007, 2011–2013 🇺🇸 1978, 1980–1981, 1985–1988, 1990–1998, 2011–2013
🇮🇪 1982–1988, 2009–2013

Austerity measures have dampened growth in Europe

Fiscal consolidation increases inequality

Fiscal consolidation: Spending versus taxes

Larger effect for spending-based consolidation

Fiscal consolidation increases (long-term) unemployment

Monetary policy

Effects of contractionary monetary policy shocks

Study by Furceri et al. (2018):

  • (unanticipated) changes in short-term interest rates for a panel of 32 countries from 1990 to 2013
  • contractionary monetary policy shocks increase income inequality, expansionary monetary policy reduces inequality
  • effect is asymmetric: tightening of monetary policy raises inequality more than easing lowers it

Effect of monetary policy on output, unemployment and inflation

Effect of monetary policy shocks on inequality

Empirical evidence in single countries is ambiguous

  • Anderesen et al. (2023) find for Denmark (1987-2014) that expansionary monetary policy (reduction of rates) leads to more inequality.
  • Mumtaz/Theophilopoulou (2017) suggest for the United Kingdom (1969-2012) that contractionary monetary policy resulted in increasing income inequality.
  • Coibion et al. (2017) argue that contractionary monetary policy shocks boosted inequality in the United States since 1980.
  • McKay/Wolf (2023) find that monetary policy has a relatively uniform incidence across households in the United States.

Themes

Themes

Main theme components

data |> ggplot(aes(x = var1, y = var2)) |>
  geom_line() +
  theme_minimal() +
  theme(plot.background = element_rect(fill = "red"),
        panel.grid.x = element_blank(),
        axis.line.x = element_line(linewidth = 1.2),
        legend.text = element_text(size = 7),
        legend.position = "top")


Plot Panel Axis Legend Strip
background background title background background
title border text key placement
subtitle grid ticks title text
caption spacing line text
margin position

Bibliography

Agnello, Luca/Sousa, Ricardo M. (2014). How Does Fiscal Consolidation Impact on Income Inequality? Review of Income and Wealth, 60(4), 702–726. DOI: 10.1111/roiw.12004
Anderesen, Asger Lau/Johannesen, Niels/Jørgensen, Mia/Peydró, José-Luis (2023). Monetary Policy and Inequality. The Journal of Finance, 78(5), 2945–2989. DOI: 10.1111/jofi.13262
Ball, Laurence/Furceri, Davide/Leigh, Daniel/Loungani, Prakash (2013). The distributional effects of fiscal consolidation (Working Paper No. WP/13/151). IMF.
Coibion, Olivier/Gorodnichenko, Yuriy/Kueng, Lorenz/Silvia, John (2017). Innocent Bystanders? Monetary Policy and Inequality. Journal of Monetary Economics, 88, 70–89. DOI: 10.1016/j.jmoneco.2017.05.005
Devries, Pete/Guajardo, Jaime/Leigh, Daniel/Pescatori, Andrea (2011). A new action-based dataset of fiscal consolidation (Working Paper No. WP/11/128). IMF.
Furceri, Davide/Loungani, Prakash/Zdzienicka, Aleksandra (2018). The Effects of Monetary Policy Shocks on Inequality. Journal of International Money and Finance, 85, 168–186. DOI: 10.1016/j.jimonfin.2017.11.004
Heimberger, Philipp (2020). The Dynamic Effects of Fiscal Consolidation Episodes on Income Inequality: Evidence for 17 OECD Countries over 19782013. Empirica, 47(1), 53–81. DOI: 10.1007/s10663-018-9404-z
Jordà, Òscar (2005). Estimation and Inference of Impulse Responses by Local Projections. American Economic Review, 95(1), 161–182. DOI: 10.1257/0002828053828518
McKay, Alisdair/Wolf, Christian K. (2023). Monetary Policy and Inequality. Journal of Economic Perspectives, 37(1), 121–144. DOI: 10.1257/jep.37.1.121
Mumtaz, Haroon/Theophilopoulou, Angeliki (2017). The Impact of Monetary Policy on Inequality in the UK. An Empirical Analysis. European Economic Review, 98, 410–423. DOI: 10.1016/j.euroecorev.2017.07.008
Woo, Jaejoon/Bova, Elva/Kinda, Tidiane/Zhang, Y. Sophia (2016). Distributional Consequences of Fiscal Adjustments: What Do the Data Say? IMF Economic Review, 65(2), 273–307. DOI: 10.1057/s41308-016-0021-1