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Politically Optimal Fiscal Policy

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  • Irina Yakadina
  • Michael Kumhof

Abstract

Why do governments issue large amounts of debt? In what sense and for whom is such a policy optimal? We show that twisting the optimal taxation paradigm produces very reasonable predictions for debt and real interest rates. Adding an extra dimension of uncertainty about the political planning horizon gives rise to a positive and very plausible government debt-to-GDP ratio of about 55 percent in a model that otherwise predicts negative government debt. We quantify the impact of political uncertainty on steady state and business cycle dynamics. We illustrate how populist tax cuts can cause business cycle fluctuations.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/68.

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Length: 26
Date of creation: 01 Mar 2007
Date of revision:
Handle: RePEc:imf:imfwpa:07/68

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Keywords: Public debt; Gross domestic product; Tax changes; taxation; fiscal policy; government spending; equation; equations; predictions; correlation; stochastic process; calibration; government budget; budget deficits; budget constraint; monte carlo simulations; fiscal policy outcomes; tax cuts; fiscal variables; prediction; primary deficit; stochastic processes; statistics; standard deviations; horizontal axis; budgetary implications; reduction in tax; primary fiscal deficit; nonlinear regressions; tax rates; quadratic equation; fiscal adjustment; fiscal deficits; general equilibrium models; survey; fiscal deficit; budgetary adjustment; government budget constraint; perturbation; government budget balance; fiscal shock; fiscal shocks; integrals; random walk; budget balance; fiscal policies; polynomials; fiscal spending; tax revenue;

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References

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Cited by:
  1. Rieth, Malte, 2014. "Myopic governments and welfare-enhancing debt limits," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 38(C), pages 250-265.
  2. Marina Azzimonti, 2011. "The dynamics of public investment under persistent electoral advantage," Working Papers 11-23, Federal Reserve Bank of Philadelphia.
  3. Paolo Biraschi, . "Searching for the optimal EMU fiscal rule:an ex-post analysis of the SGP reform proposals," Working Papers, Department of the Treasury, Ministry of the Economy and of Finance wp2008-7, Department of the Treasury, Ministry of the Economy and of Finance.

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