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

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  • Salvador Ortigueira

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  • Joana Pereira

    ()

  • Paul Pichler

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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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File URL: http://e-archivo.uc3m.es/bitstream/10016/15788/1/we1230.pdf
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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. Robert G. King & Alexander L. Wolman, 2004. "Monetary Discretion, Pricing Complementarity, and Dynamic Multiple Equilibria," The Quarterly Journal of Economics, MIT Press, vol. 119(4), pages 1513-1553, November.
  2. Díaz-Giménez, Javier & Giovannetti, Giorgia & Marimon, Ramon & Teles, Pedro, 2007. "Nominal Debt as a Burden on Monetary Policy," CEPR Discussion Papers 6595, C.E.P.R. Discussion Papers.
  3. Andrew P. Blake & Tatiana Kirsanova, 2012. "Discretionary Policy and Multiple Equilibria in LQ RE Models," Review of Economic Studies, Oxford University Press, vol. 79(4), pages 1309-1339.
  4. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
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  6. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711, December.
  7. Per Krusell & Fernando M. Martin & Jose-Victor Rios-Rull, 2006. "Time Consistent Debt," 2006 Meeting Papers 210, Society for Economic Dynamics.
  8. Stefania Albanesi & V. V. Chari & Lawrence J. Christiano, 2002. "Expectation Traps and Monetary Policy," Macroeconomics 0201004, EconWPA.
  9. Catarina Reis, 2007. "Taxation without Commitment," 2007 Meeting Papers 470, Society for Economic Dynamics.
  10. 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.
  11. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-61, September.
  12. Persson, Mats & Persson, Torsten & Svensson, Lars E O, 1987. "Time Consistency of Fiscal and Monetary Policy," Econometrica, Econometric Society, vol. 55(6), pages 1419-31, November.
  13. repec:bla:restud:v:75:y:2008:i:3:p:789-808 is not listed on IDEAS
  14. 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.
  15. Zheng Song & Kjetil Storesletten & Fabrizio Zilibotti, 2007. "Rotten parents and disciplined children: a politico-economic theory of public expenditure and debt," IEW - Working Papers 325, Institute for Empirical Research in Economics - University of Zurich.
  16. 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, vol. 44(4), pages 1217-1245, November.
  17. Davide Debortoli & Ricardo Nunes, 2013. "Lack Of Commitment And The Level Of Debt," Journal of the European Economic Association, European Economic Association, vol. 11(5), pages 1053-1078, October.
  18. Judd, Kenneth L., 1985. "Redistributive taxation in a simple perfect foresight model," Journal of Public Economics, Elsevier, vol. 28(1), pages 59-83, October.
  19. 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 06-08, University of Delaware, Department of Economics.
  20. Dominguez, Begona, 2007. "Public debt and optimal taxes without commitment," Journal of Economic Theory, Elsevier, vol. 135(1), pages 159-170, July.
  21. Judd, Kenneth L., 1992. "Projection methods for solving aggregate growth models," Journal of Economic Theory, Elsevier, vol. 58(2), pages 410-452, December.
  22. 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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Cited by:
  1. Azzimonti, Marina & Sarte, Pierre-Daniel & Soares, Jorge, 2009. "Distortionary taxes and public investment when government promises are not enforceable," Journal of Economic Dynamics and Control, Elsevier, vol. 33(9), pages 1662-1681, September.
  2. Niemann, Stefan, 2011. "Dynamic monetary–fiscal interactions and the role of monetary conservatism," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 234-247.
  3. Stefan Niemann & Paul Pichler, 2013. "Collateral, Liquidity and Debt Sustainability," Working Papers 187, Oesterreichische Nationalbank (Austrian Central Bank).
  4. Ricardo Nunes & Davide Debortoli, 2011. "Political Disagreement, Lack of Commitment and the Level of Debt," 2011 Meeting Papers 127, Society for Economic Dynamics.
  5. Dennis, Richard, 2013. "Asset Prices, Business Cycles, and Markov-Perfect Fiscal Policy when Agents are Risk-Sensitive," SIRE Discussion Papers 2013-79, Scottish Institute for Research in Economics (SIRE).
  6. Fernando M. Martin, 2011. "Policy and welfare effects of within-period commitment," Working Papers 2011-031, Federal Reserve Bank of St. Louis.
  7. 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.
  8. Stefan Niemann & Paul Pichler & Gerhard Sorger, 2008. "Optimal Fiscal and Monetary Policy Without Commitment," Economics Discussion Papers 654, University of Essex, Department of Economics.

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