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Markov-perfect optimal fiscal policy : the case of unbalanced budgets

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  • Salvador Ortigueira

    ()

  • Joana Pereira

    ()

  • Paul Pichler

    ()

Abstract

We study optimal time-consistent fiscal policy in a neoclassical economy with endogenous government spending, physical capital and public debt. We show that a dynamic complementarity between the households’ consumption-savings decision and the government’s policy decision gives rise to a multiplicity of expectations-driven Markov-perfect equilibria. The long-run levels of taxes, government spending and debt are not uniquely pinned down by economic fundamentals, but are determined by expectations over current and future policies. Accordingly, economies with identical fundamentals may significantly differ in their levels of public indebtedness

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Bibliographic Info

Paper provided by Universidad Carlos III, Departamento de Economía in its series Economics Working Papers with number we1230.

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Date of creation: Oct 2012
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Handle: RePEc:cte:werepe:we1230

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Keywords: Optimal fiscal policy; Markov-perfect equilibrium; Time-consistent policy; Expectation traps;

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References

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  1. Jorge Soares, Marina Azzimonti, Pierre-Daniel Sarte & Pierre-Daniel Sarte & Jorge Soares, 2006. "Optimal Policy and (the Lack of) Time Inconsistency: Insights from Simple Models," Working Papers, University of Delaware, Department of Economics 06-08, University of Delaware, Department of Economics.
  2. Ramon Marimon & Javier Díaz-Giménez & Giorgia Giovannetti & Pedro Teles, 2007. "Nominal Debt as a Burden on Monetary Policy," NBER Working Papers 13677, National Bureau of Economic Research, Inc.
  3. Robert G. King & Alexander L. Wolman, 2004. "Monetary Discretion, Pricing Complementarity, and Dynamic Multiple Equilibria," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 119(4), pages 1513-1553, November.
  4. Zheng Song & Kjetil Storesletten & Fabrizio Zilibotti, 2007. "Rotten Parents and Disciplined Children: A Politico-Economic Theory of Public Expenditure and Debt," 2007 Meeting Papers, Society for Economic Dynamics 685, Society for Economic Dynamics.
  5. Stefania Albanesi & V. V. Chari & Lawrence J. Christiano, 2003. "Expectation Traps and Monetary Policy," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 70(4), pages 715-741, October.
  6. Dominguez, Begona, 2007. "Public debt and optimal taxes without commitment," Journal of Economic Theory, Elsevier, Elsevier, vol. 135(1), pages 159-170, July.
  7. Kenneth L. Judd, 1982. "Redistributive Taxation in a Simple Perfect Foresight Model," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 572, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  8. Persson, Mats & Persson, Torsten & Svensson, Lars E O, 1987. "Time Consistency of Fiscal and Monetary Policy," Econometrica, Econometric Society, Econometric Society, vol. 55(6), pages 1419-31, November.
  9. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, Econometric Society, vol. 54(3), pages 607-22, May.
  10. Catarina Reis, 2007. "Taxation without Commitment," 2007 Meeting Papers, Society for Economic Dynamics 470, Society for Economic Dynamics.
  11. Per Krusell & Fernando M. Martin & Jose-Victor Rios-Rull, 2006. "Time Consistent Debt," 2006 Meeting Papers, Society for Economic Dynamics 210, Society for Economic Dynamics.
  12. Davide Debortoli & Ricardo Nunes, 2013. "Lack Of Commitment And The Level Of Debt," Journal of the European Economic Association, European Economic Association, European Economic Association, vol. 11(5), pages 1053-1078, October.
  13. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262100711, December.
  14. Andrew Blake & Tatiana Kirsanova, 2008. "Discretionary Policy and Multiple Equilibria in LQ RE Models," Discussion Papers, Exeter University, Department of Economics 0813, Exeter University, Department of Economics.
  15. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  16. Paul Klein & Per Krusell & José-V�ctor R�os-Rull, 2008. "Time-Consistent Public Policy," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 789-808.
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  18. Fernando Martin, 2009. "A Positive Theory of Government Debt," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(4), pages 608-631, October.
  19. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, American Economic Association, vol. 78(4), pages 647-61, September.
  20. Paul Klein & JosÈ-VÌctor RÌos-Rull, 2003. "Time-consistent optimal fiscal policy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(4), pages 1217-1245, November.
  21. Judd, Kenneth L., 1992. "Projection methods for solving aggregate growth models," Journal of Economic Theory, Elsevier, Elsevier, vol. 58(2), pages 410-452, December.
  22. Salvador Ortigueira, 2006. "Markov-Perfect Optimal Taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(1), pages 153-178, January.
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Citations

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Cited by:
  1. Richard Dennis, 2013. "Asset Prices, Business Cycles, and Markov-Perfect Fiscal Policy when Agents are Risk-Sensitive," Working Papers, Business School - Economics, University of Glasgow 2013_15, Business School - Economics, University of Glasgow.
  2. Niemann, Stefan, 2011. "Dynamic monetary–fiscal interactions and the role of monetary conservatism," Journal of Monetary Economics, Elsevier, Elsevier, vol. 58(3), pages 234-247.
  3. Fernando M. Martin, 2011. "Policy and welfare effects of within-period commitment," Working Papers, Federal Reserve Bank of St. Louis 2011-031, Federal Reserve Bank of St. Louis.
  4. Jorge Soares, Marina Azzimonti, Pierre-Daniel Sarte & Pierre-Daniel Sarte & Jorge Soares, 2006. "Distortionary Taxes and Public Investment When Government Promises Are Not Enforceable," Working Papers, University of Delaware, Department of Economics 06-07, University of Delaware, Department of Economics.
  5. Richard Dennis & Tatiana Kirsanova, 2010. "Expectations Traps and Coordination Failures:Selecting Among Multiple Discretionary Equilibria," CAMA Working Papers 2010-02, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  6. Ricardo Nunes & Davide Debortoli, 2011. "Political Disagreement, Lack of Commitment and the Level of Debt," 2011 Meeting Papers 127, Society for Economic Dynamics.
  7. Stefan Niemann & Paul Pichler & Gerhard Sorger, 2008. "Optimal Fiscal and Monetary Policy Without Commitment," Economics Discussion Papers, University of Essex, Department of Economics 654, University of Essex, Department of Economics.
  8. Stefan Niemann & Paul Pichler, 2013. "Collateral, Liquidity and Debt Sustainability," Working Papers, Oesterreichische Nationalbank (Austrian Central Bank) 187, Oesterreichische Nationalbank (Austrian Central Bank).

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