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Uncertainty and the Design of Long-Run Fiscal Policy

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Author Info
Alan J. Auerbach
Kevin A. Hassett

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Abstract

This paper explores optimal fiscal policy in an overlapping-generations general-equilibrium model under uncertainty and the impact on optimal policy of the introduction of a type of policy stickiness intended to account for the stylized fact that major reforms happen infrequently. In general, our analysis suggests not only that action should not be delayed, but further that action should actually be accelerated. The added realism of restrictions on the frequency of policy changes alters this result in two ways. The prospect of being unable to set policy in the future occasions even more precautionary saving today, if the government acts. However, the government may also choose not to set policy, and its inaction range is very asymmetric. Because the impact of its policies on the current elderly cannot be reversed in the future, the government is much more likely to choose inaction when fiscal tightening is called for. Thus, the optimal policy response over time might best be characterized by great caution in general, but punctuated by occasional periods of apparent irresponsibility.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7036.

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Date of creation: Mar 1999
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Publication status: published as Auerbach, A. J. and K. A. Hassett. "Fiscal Policy And Uncertainty," International Finance, 2002, v5(2,Summer), 229-249. Demographic Change and Fiscal Policy, Auerbach, A. and R. Lee, eds., Cambridge: Cambridge University Press, forthcoming.
Handle: RePEc:nbr:nberwo:7036

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Find related papers by JEL classification:
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus

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  1. 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. [Downloadable!] (restricted)
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  2. Henning Bohn, 1998. "Risk Sharing in a Stochastic Overlapping Generations Economy," University of California at Santa Barbara, Economics Working Paper Series wp3-98, Department of Economics, UC Santa Barbara. [Downloadable!]
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  3. Laurence J. Kotlikoff & Bernd Raffelhuschen, 1999. "Generational Accounting around the Globe," American Economic Review, American Economic Association, vol. 89(2), pages 161-166, May. [Downloadable!] (restricted)
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  4. Peter Diamond, 2004. "Social Security," American Economic Review, American Economic Association, vol. 94(1), pages 1-24, March. [Downloadable!] (restricted)
  5. 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)
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  6. repec:fth:calaec:03-98 is not listed on IDEAS
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  1. S. Nuri Erbas, 2002. "Primer on Reforms in a Second-Best Ambiguous Environment: A Case for Gradualism," IMF Working Papers 02/50, International Monetary Fund. [Downloadable!]
  2. Laurence J. Kotlikoff, 2001. "Generational Policy," NBER Working Papers 8163, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
    • Kotlikoff, Laurence J., 2002. "Generational policy," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 4, chapter 27, pages 1873-1932 Elsevier. [Downloadable!] (restricted)
  3. Kruse, Agneta, 2002. "Ageing Populations and Intergenerational Risk-sharing in PAYG Pension Schemes," Working Papers 2002:18, Lund University, Department of Economics. [Downloadable!]
  4. John Stephenson & Grant Scobie, 2002. "The Economics of Population Ageing," Treasury Working Paper Series 02/04, New Zealand Treasury. [Downloadable!]
  5. Jukka Lassila & Tarmo Valkonen, 2007. "Longevity Adjustment of Pension Benefits," Discussion Papers 1073, The Research Institute of the Finnish Economy. [Downloadable!]
  6. Sally Wallace & James Alm, 2004. "The Jamaican Individual Income Tax," International Studies Program Working Paper Series, at AYSPS, GSU paper0430, International Studies Program, Andrew Young School of Policy Studies, Georgia State University. [Downloadable!]
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