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Politically Optimal Fiscal Policy

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Author Info
Michael Kumhof
Irina Yakadina

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

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Length: 26 pages
Date of creation: 29 Mar 2007
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Handle: RePEc:imf:imfwpa:07/68

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Related research
Keywords: Optimal Fiscal Policy ; Incomplete Asset Markets ; Political economy ; government debt bias ; Fiscal policy ; Public debt ; Gross domestic product ; Political economy ; Tax changes ; Business cycles ;

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References listed on IDEAS
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    Other versions:
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    Other versions:
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    Other versions:
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    Other versions:
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  16. Alesina, Alberto & Tabellini, Guido, 1990. "A Positive Theory of Fiscal Deficits and Government Debt," Review of Economic Studies, Blackwell Publishing, vol. 57(3), pages 403-14, July. [Downloadable!] (restricted)
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  21. Chari, V V & Christiano, Lawrence J & Kehoe, Patrick J, 1994. "Optimal Fiscal Policy in a Business Cycle Model," Journal of Political Economy, University of Chicago Press, vol. 102(4), pages 617-52, August. [Downloadable!] (restricted)
    Other versions:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Paolo Biraschi, . "Searching for the optimal EMU fiscal rule:an ex-post analysis of the SGP reform proposals," Working Papers wp2008-7, Department of the Treasury, Ministry of the Economy and of Finance. [Downloadable!]
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