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Tax Smoothing with Stochastic Interest Rates: A Re-assessment of Clinton's Fiscal Legacy

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  • Huw Lloyd-Ellis

    ()
    (CREFE and Queen's University)

  • Shiqiang Zhang

    (University of Chicago)

  • Xiaodong Zhu

    ()
    (University of Toronto)

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. In this article, we evaluate post-war, US fiscal policy using an extension of Barro's (1979) tax-smoothing model, generalized to allow for stochastic variation in interest rates and growth rates. We show that the evolution of the US debt-GDP ratio has been remarkably consistent with the tax-smoothing paradigm, even during the 1980s. The only major departure occurred during the late 1990s, when the debt-GDP ratio fell more rapidly than predicted by optimal tax smoothing. Le retour vers une politique fiscale raisonnable après les déficits budgétaires élevés des années 1980 et du début des années 1990 a été acclamé par beaucoup comme la réalisation la plus importante de l'administration Clinton. Dans cet article, nous évaluons la politique fiscale des États-Unis d'après-guerre en utilisant une extension du modèle de lissage des impôts de Barro (1979), modèle généralisé pour permettre des variations stochastiques des taux d'intérêt et des taux de croissance. Nous montrons que l'évolution de ratio dette/PIB américain a été remarquablement conséquent avec le paradigme de lissage des impôts, même durant les années 1980. Le seul écart important a eu lieu durant la fin des années 1990, lorsque le ratio dette/PIB est tombé plus rapidement que ce qu'aurait prédit un lissage optimal des impôts.

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Bibliographic Info

Paper provided by CREFE, Université du Québec à Montréal in its series Cahiers de recherche CREFE / CREFE Working Papers with number 125.

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Length: 30 pages
Date of creation: Feb 2001
Date of revision:
Handle: RePEc:cre:crefwp:125

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Keywords: public debt; tax smoothing; stochastic discouting;

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  1. H. Lloyd-Ellis & Xiaodong Zhu, 1998. "Fiscal Shocks and Fiscal Risk Management," Working Papers lloydell-98-01, University of Toronto, Department of Economics.
  2. John Y. Campbell & Luis M. Viceira, 2000. "Who Should Buy Long-Term Bonds?," Harvard Institute of Economic Research Working Papers 1895, Harvard - Institute of Economic Research.
  3. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  4. 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.
  5. Plosser, Charles I., 1982. "Government financing decisions and asset returns," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 325-352.
  6. Alberto Alesina & Roberto Perotti, 1994. "The Political Economy of Budget Deficits," NBER Working Papers 4637, National Bureau of Economic Research, Inc.
  7. V.V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal fiscal policy in a business cycle model," Staff Report 160, Federal Reserve Bank of Minneapolis.
  8. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October.
  9. Ravi Jagannathan & Zhenyu Wang, 1996. "The conditional CAPM and the cross-section of expected returns," Staff Report 208, Federal Reserve Bank of Minneapolis.
  10. Bohn, Henning, 1995. "The Sustainability of Budget Deficits in a Stochastic Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(1), pages 257-71, February.
  11. 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.
  12. Zhu, Xiaodong, 1992. "Optimal fiscal policy in a stochastic growth model," Journal of Economic Theory, Elsevier, vol. 58(2), pages 250-289, December.
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Cited by:
  1. Luo, Yulei & Nie, Jun & Young, Eric, 2014. "Model Uncertainty and Intertemporal Tax Smoothing," MPRA Paper 54268, University Library of Munich, Germany.
  2. Evan Tanner, 2013. "Fiscal Sustainability," IMF Working Papers 13/89, International Monetary Fund.
  3. 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.

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