Large pending fiscal policy changes, such as in the United States in 2012 or in Japan with consumption taxes, often generate considerable uncertainty. “Fiscal cliff” episodes have several features: an announced possible future change, a skewed set of possible out-comes, the possibility that implementation may not actually occur, and a known resolution date. This paper develops a model capturing these features and studies their impact. Fiscal cliff uncertainty shocks have immediate impact, with a magnitude that depends on the probability of implementation, which generates economic volatility. The possibility of fiscal cliffs lowers economic activity even in periods of relative certainty.
Foerster, Andrew, and Troy Davig. 2018. “Uncertainty and Fiscal Cliffs,” Federal Reserve Bank of San Francisco Working Paper 2018-12. Available at https://doi.org/10.24148/wp2018-12