Fiscal policy as a stabilization instrument

This paper investigates the role of the fiscal authority in the case in which a negative shock hits the economic system. We analyze the several kinds of behavior that the fiscal authority can adopt during a crisis and show how the various approaches impact upon the effectiveness of fiscal policy. In general, there are two approaches: a) Adopt a neutral behavior or b) Adopt an active behavior in order to stabilize output volatility caused by a slump. Using a constrained minimization process it emerges that the mere use of a monetary policy is ineffective to counteract the crisis, with the risk of keeping the system in a situation in which aggregate demand falls below the potential output. In this context, an expansionary fiscal policy may be crucial to restore the output equilibrium.