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Debt Stabilization in a Non-Ricardian Economy

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  • Simon Wren-Lewis
  • Campbell Leith and Ioana Moldovan

Abstract

In models with a representative infinitely lived household, modern versions of tax smoothing imply that the steady-state of government debt should follow a random walk.� This is unlikely to be the case in OLG economies, where the equilibrium interest rate may differ from the policy-maker's rate of time preference such that it may be optimal to reduce debt today to reduce distortionary taxation in the future.� Moreover, the level of the capital stock (and therefore output and consumption) in these economies is likely to be sub-optimally low, and reducing government debt will 'crowd in' additional capital.� Using an elaborated version of the model of perpetual youth developed by Blanchard (1985) and Yaari (1985), we derive the optimal steady state level of government assets.� We show how and why this level of government assets falls short of the level of debt that achieves the optimal capital stock and the level that eliminates income taxes.

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Bibliographic Info

Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 542.

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Date of creation: 01 Mar 2011
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Handle: RePEc:oxf:wpaper:542

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Keywords: Non-Ricardian consumers; Macroeconomic stability; Distortionary taxes;

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References

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  1. Calvo, Guillermo A & Obstfeld, Maurice, 1988. "Optimal Time-Consistent Fiscal Policy with Finite Lifetimes," Econometrica, Econometric Society, vol. 56(2), pages 411-32, March.
  2. Leith, Campbell & Wren-Lewis, Simon, 2011. "Discretionary policy in a monetary union with sovereign debt," European Economic Review, Elsevier, vol. 55(1), pages 93-117, January.
  3. 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.
  4. S. Rao Aiyagari & Albert Marcet & Thomas J. Sargent & Juha Seppala, 2002. "Optimal Taxation without State-Contingent Debt," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1220-1254, December.
  5. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  6. Simon Wren-Lewis & Campbell Leith, 2007. "Fiscal Sustainability in a New Keynesian Model," Economics Series Working Papers 310, University of Oxford, Department of Economics.
  7. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  8. Leith, Campbell & Wren-Lewis, Simon, 2000. "Interactions between Monetary and Fiscal Policy Rules," Economic Journal, Royal Economic Society, vol. 110(462), pages C93-108, March.
  9. Leith, Campbell & Malley, Jim, 2005. "Estimated general equilibrium models for the evaluation of monetary policy in the US and Europe," European Economic Review, Elsevier, vol. 49(8), pages 2137-2159, November.
  10. Ascari, Guido & Rankin, Neil, 2007. "Perpetual youth and endogenous labor supply: A problem and a possible solution," Journal of Macroeconomics, Elsevier, vol. 29(4), pages 708-723, December.
  11. Agresti, Anna Maria & Mojon, Benoît, 2001. "Some stylised facts on the euro area business cycle," Working Paper Series 0095, European Central Bank.
  12. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  13. Andres Erosa & Martin Gervais, 2001. "Optimal taxation in infinitely-lived agent and overlapping generations models : a review," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 23-44.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. The long run government debt target
    by Mainly Macro in Mainly Macro on 2013-01-11 18:11:00
  2. Optimal Debt Policy for Ireland (Warning: Wonkish)
    by John McHale in The Irish Economy on 2013-02-12 22:22:43

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