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Tax Smoothing with Stochastic Interest Rates: A Reassessment of Clinton's Fiscal Legacy

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  • Lloyd-Ellis, Huw
  • Zhan, Shiqiang
  • Zhu, Xiaodong

Abstract

The return to "sound" fiscal policy after the high budget deficits of the 1980s and early 1990s has been hailed by many as the Clinton administration's most important achievement. We evaluate post-war, U.S. fiscal policy using a generalized tax-smoothing model that allows for stochastic interest rates and growth rates. We show that contrary to conventional wisdom, the evolution of the U.S. debt-GDP ratio during the 1980s was remarkably consistent with the tax-smoothing paradigm. In fact, a more substantial departure occurred during the late 1990s, when the debt-GDP ratio fell more rapidly than predicted by optimal tax smoothing.

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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 37 (2005)
Issue (Month): 4 (August)
Pages: 699-724

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Handle: RePEc:mcb:jmoncb:v:37:y:2005:i:4:p:699-724

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
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  7. Albert Marcet & Thomas J. Sargent & Juha Seppala, 1996. "Optimal taxation without state-contingent debt," Economics Working Papers 170, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2001.
  8. Bohn, H., 1990. "The Sutainability Of Budget Deficits In A Stochastic Economy," Weiss Center Working Papers 6-90, Wharton School - Weiss Center for International Financial Research.
  9. Nouriel Roubini & Jeffrey Sachs, 1988. "Political and Economic Determinants of Budget Deficits in the IndustrialDemocracies," NBER Working Papers 2682, National Bureau of Economic Research, Inc.
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Cited by:
  1. Evan Tanner, 2013. "Fiscal Sustainability," IMF Working Papers 13/89, International Monetary Fund.
  2. Angyridis, Constantine, 2009. "Balanced budget vs. Tax smoothing in a small open economy: A welfare comparison," Journal of Macroeconomics, Elsevier, vol. 31(3), pages 438-463, September.
  3. Luo, Yulei & Nie, Jun & Young, Eric, 2014. "Model Uncertainty and Intertemporal Tax Smoothing," MPRA Paper 54268, University Library of Munich, Germany.

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