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Optimal Long-Run Fiscal Policy: Constraints, Preferences and the Resolution of Uncertainty

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  • Alan J. Auerbach
  • Kevin A. Hassett

Abstract

We construct a computational dynamic stochastic overlapping generations general equilibrium model with uncertain lifetimes and explore the impact of policy stickiness (specifically, a major reform will preclude future reforms for a generation) on optimal long-run fiscal policy. Under such circumstances, entitlement reforms exhaust a valuable option to move in the future. We explore the conditions under which the gain to waiting is large enough to induce optimizing policymakers to delay reforming a suboptimal system. We also allow for the uncertainty to have ARCH characteristics and explore the impact of time-varying uncertainty on the optimality of delayed policy action.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9132.

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Date of creation: Aug 2002
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Publication status: published as Auerbach, Alan J. & Hassett, Kevin, 2007. "Optimal long-run fiscal policy: Constraints, preferences and the resolution of uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 31(5), pages 1451-1472, May.
Handle: RePEc:nbr:nberwo:9132

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  1. Bernd Raffelhuschen & Laurence J. Kotlikoff, 1999. "Generational Accounting around the Globe," American Economic Review, American Economic Association, American Economic Association, vol. 89(2), pages 161-166, May.
  2. Auerbach, Alan J. & Kotlikoff, Laurence J. & Leibfritz, Willi (ed.), 1999. "Generational Accounting around the World," National Bureau of Economic Research Books, University of Chicago Press, edition 1, number 9780226032139, 01-2013.
  3. David Schmeidler, 1989. "Subjective Probability and Expected Utility without Additivity," Levine's Working Paper Archive 7662, David K. Levine.
  4. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262100711, December.
  5. Alan J. Auerbach & Kevin A. Hassett, 1999. "Uncertainty and the Design of Long-Run Fiscal Policy," NBER Working Papers 7036, National Bureau of Economic Research, Inc.
  6. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  7. Sheshinski, Eytan & Weiss, Yoram, 1981. "Uncertainty and Optimal Social Security Systems," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 96(2), pages 189-206, May.
  8. Henning Bohn, 2001. "Social Security and Demographic Uncertainty: The Risk-Sharing Properties of Alternative Policies," NBER Chapters, National Bureau of Economic Research, Inc, in: Risk Aspects of Investment-Based Social Security Reform, pages 203-246 National Bureau of Economic Research, Inc.
  9. Martin Feldstein & Jeffrey B. Liebman, 2001. "Social Security," NBER Working Papers 8451, National Bureau of Economic Research, Inc.
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