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Anticipated Ramsey Reforms and the Uniform Taxation Principle: The Role of International Financial Markets

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  • Schmitt-Grohé, Stephanie
  • Uribe, Martín

Abstract

This Paper studies the role of asset-market completeness for the properties of optimal policy. A suitable framework for this purpose is the small open economy with complete international asset markets. For in this environment changes in policy represent country-specific risk diversifiable in world markets. Our main finding is that the fundamental public finance principle whereby when taxes on all final goods are available, it is optimal to tax final goods uniformly fails to obtain. In general, uniform taxation is optimal because it amounts to a non-distorting tax on fixed factors of production. In the open economy this principle fails because when households can insure against the risk of a policy reform, initial private asset holdings are contingent on actual policy and thus no longer represent an inelastically supplied source of income. Two further differences between optimal policy in the closed and open economies with complete markets are: (a) In the open economy, optimal consumption and income tax rates are unchanged in response to government purchases shocks. By contrast, in the closed economy tax rates do respond to innovations in public spending. (b) In the open economy, the Friedman rule is optimal only if the Ramsey planner has access to consumption taxes. In the absence of consumption taxes, deviations from the Friedman rule are large. On the other hand, in the closed economy, the availability of either consumption or income taxes suffices to render the Friedman rule optimal.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3438.

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Date of creation: Jun 2002
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Handle: RePEc:cpr:ceprdp:3438

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Keywords: anticipated ramsey policy; open economies; optimal monetary and fiscal policy;

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Cited by:
  1. David M. Arseneau, 2004. "Expectation traps in a New Keynesian open economy model," Finance and Economics Discussion Series 2004-45, Board of Governors of the Federal Reserve System (U.S.).
  2. Juan Pablo Medina & Ruy Lama, 2005. "Optimal Monetary Policy in a Small Open Economy under Segmented Asset Markets and Sticky Prices," 2005 Meeting Papers 774, Society for Economic Dynamics.
  3. Ascari, Guido & Rankin, Neil, 2004. "Perpetual youth and endogenous labour supply: a problem and a possible solution," Working Paper Series 0346, European Central Bank.
  4. Senay, Ozge & Sutherland, Alan, 2010. "The Timing of Asset Trade and Optimal Policy in Dynamic Open Economies," SIRE Discussion Papers 2010-60, Scottish Institute for Research in Economics (SIRE).
  5. Faia, Ester & Monacelli, Tommaso, 2004. "Ramsey monetary policy and international relative prices," Working Paper Series 0344, European Central Bank.
  6. Florina-Cristina Badarau & Florence Huart & Ibrahima Sangaré, 2013. "Indebtedness and macroeconomic imbalances in a monetary-union DSGE model," Working Papers hal-00996622, HAL.
  7. Liu, X, 2010. "Is Optimal Monetary and Fiscal Policy in a Small Open Economy Time Consistent?," MPRA Paper 28781, University Library of Munich, Germany.
  8. Liu, Xuan, 2013. "Time consistency of optimal monetary and fiscal policy in a small open economy," Journal of International Money and Finance, Elsevier, vol. 36(C), pages 47-67.
  9. Alexandre B. Cunha, 2005. "The Optimality of the Friedman Rule When Some Distorting Taxes Are Exogenous," IBMEC RJ Economics Discussion Papers 2005-06, Economics Research Group, IBMEC Business School - Rio de Janeiro.
  10. Alexandre Cunha, 2004. "The Friedman Rule in a Two Sector Small Open Economy," Econometric Society 2004 North American Summer Meetings 530, Econometric Society.

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