The Savers–Spenders Theory of Fiscal Policy

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Submitted By pl415
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The Savers–Spenders Theory of Fiscal Policy
The literature on the macroeconomic effects of fiscal policy and, in particular, of government debt is founded on two canonical models. The purpose of this paper is to suggest that both models are deficient and to propose a new model to take their place.
The first canonical model is the Barro-Ramsey model of infinitely-lived families (Robert Barro,
1974). According to this model, the government’s debt policy redistributes the tax burden among generations, but families, who want to smooth their consumption over time, reverse the effects of this redistribution through their bequests. Government debt is completely neutral—a proposition called Ricardian equivalence.
The second canonical model of government debt is the Diamond-Samuelson model of overlapping generations (Peter Diamond, 1965). In this model, people smooth consumption over their own lifetimes, but there is no bequest motive. When the government issues debt, it enriches some generations at the expense of others, crowds out capital, and reduces steadystate living standards.
In this paper, I first discuss the facts that lead me to reject these canonical models. I then propose an alternative model and develop briefly its implications for fiscal policy.

consumption over time. There is much reason to be skeptical about this assumption.
A large empirical literature, starting with
Robert Hall’s (1978) seminal random-walk theorem, has addressed the question of how well households intertemporally smooth their consumption. Although this literature does not speak with a single voice, the consensus view is that consumption smoothing is far from perfect.
In particular, consumer spending tracks current income far more than it should.
In our 1989 paper, John Campbell and I considered a world populated with two types of…...

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