Fiscal uncertainty with donor herding and domestic debt crisis
This study attempts to analyse how uncertainty about future government spending affects the representative individual’s lifetime utility by using a discrete inter-temporal optimizing model. Intuitively, the study shows that the overall effect of a highly positive domestic-debt repayment gap is such that the expected government spending for the next period will go down. The implication of the reduction in government spending due to uncertainty about future debt servicing is that the output and the corresponding investment for the next period will be expected to go down. This outcome is further reinforced by the higher taxes imposed on consumers in an attempt to minimise the next period’s domestic-debt repayment gap.
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