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Time-Consistent Public Policy

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Author Info
PAUL KLEIN
PER KRUSELL
JOSÉ-VÍCTOR RÍOS-RULL

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Abstract

In this paper we study how a benevolent government that cannot commit to future policy should trade off the costs and benefits of public expenditure. We characterize and solve for Markov-perfect equilibria of the dynamic game between successive governments. The characterization consists of an inter-temporal first-order condition (a "generalized Euler equation") for the government, and we use it both to gain insight into the nature of the equilibrium and as a basis for computations. For a calibrated economy, we find that when the only tax base available to the government is capital income-an inelastic source of funds at any point in time-the government still refrains from taxing at confiscatory rates. We also find that when the only tax base is labour income the Markov equilibrium features less public expenditure and lower tax rates than the Ramsey equilibrium. Copyright © 2008 The Review of Economic Studies Limited.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1467-937X.2008.00491.x
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Publisher Info
Article provided by Blackwell Publishing in its journal Review of Economic Studies.

Volume (Year): 75 (2008)
Issue (Month): 3 (07)
Pages: 789-808
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Handle: RePEc:bla:restud:v:75:y:2008:i:3:p:789-808

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  1. Marcello D'Amato & Vincenzo Galasso, 2009. "Political Intergenerational Risk Sharing," CSEF Working Papers 216, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy. [Downloadable!]
    Other versions:
  2. Reis, Catarina, 2006. "Taxation without Commitment," MPRA Paper 2071, University Library of Munich, Germany. [Downloadable!]
  3. Salvador Ortigueira & Joana Pereira, 2007. "Markov-Perfect Optimal Fiscal Policy: The Case of Unbalanced Budgets," Economics Working Papers ECO2007/41, European University Institute. [Downloadable!]
  4. Stefan Niemann, 2009. "Dynamic Monetary-Fiscal Interactions and the Role of Monetary Conservatism," Economics Discussion Papers 667, University of Essex, Department of Economics. [Downloadable!]
  5. Jinhui Bai & Roger Lagunoff, 2008. "On the 'Faustian' Dynamics of Policy and Political Power," Working Papers gueconwpa~08-08-02, Georgetown University, Department of Economics. [Downloadable!]
    Other versions:
  6. Stefan Niemann & Paul Pichler & Gerhard Sorger, 2008. "Optimal Fiscal and Monetary Policy Without Commitment," Economics Discussion Papers 654, University of Essex, Department of Economics. [Downloadable!]
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