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Managing pessimistic expectations and fiscal policy

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  • Karantounias, Anastasios G.

    ()
    (Research Department, Federal Reserve Bank of Atlanta)

Abstract

This paper studies the design of optimal fiscal policy when a government that fully trusts the probability model of government expenditures faces a fearful public that forms pessimistic expectations. We identify two forces that shape our results. On the one hand, the government has an incentive to concentrate tax distortions on events that it considers unlikely relative to the pessimistic public. On the other hand, the endogeneity of the public's expectations gives rise to a novel motive for expectation management that aims towards the manipulation of equilibrium prices of government debt in a favorable way. These motives typically act in opposite directions and induce persistence to the optimal allocation and the tax rate.

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File URL: http://econtheory.org/ojs/index.php/te/article/viewFile/20130193/8138/255
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Bibliographic Info

Article provided by Econometric Society in its journal Theoretical Economics.

Volume (Year): 8 (2013)
Issue (Month): 1 (January)
Pages:

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Handle: RePEc:the:publsh:899

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Web page: http://econtheory.org

Related research

Keywords: Fiscal policy; misspecification; robustness; taxes; debt; martingale;

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References

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Cited by:
  1. Robert Baumann & Justin Svec, 2013. "The Impact of Political Uncertainty: A Robust Control Approach," Working Papers 1306, College of the Holy Cross, Department of Economics.
  2. Lars Peter Hansen & Thomas J. Sargent, 2012. "Three Types of Ambiguity," Working Papers 2012-006, Becker Friedman Institute for Research In Economics.
  3. Ryan Chahrour & Justin Svec, 2014. "Optimal Capital Taxation and Consumer Uncertainty," Boston College Working Papers in Economics 854, Boston College Department of Economics.
  4. Richard Dennis, 2013. "Asset Prices, Business Cycles, and Markov-Perfect Fiscal Policy when Agents are Risk-Sensitive," Working Papers 2013_15, Business School - Economics, University of Glasgow.
  5. Josef Hollmayr & Christian Matthes, 2013. "Learning about fiscal policy and the effects of policy uncertainty," Working Paper 13-15, Federal Reserve Bank of Richmond.
  6. Yulei Luo & Jun Nie & Eric R. Young, 2012. "Model uncertainty and intertemporal tax smoothing," Research Working Paper RWP 12-01, Federal Reserve Bank of Kansas City.
  7. Karantounias, Anastasios G., 2013. "Optimal fiscal policy with recursive preferences," Working Paper 2013-07, Federal Reserve Bank of Atlanta.

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