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The Inconsistency Puzzle Resolved: an Omitted Variable

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  • Arefiev, Nikolay

Abstract

We find that the contemporary version of the dynamic Ramsey problem omits one important variable that we take into consideration in this paper. The effect of introducing of this variable into the analysis of dynamic inconsistency is similar to that of introducing expected inflation into the Phillips curve: we show that only a policy surprise affects the attainable resource allocation set and the optimal policy. In contrast to Chamley (1986), we show that intensive capital income taxation at the beginning of optimal policy does not imply a lump-sum taxation of household wealth and cannot reduce the excess tax burden. We also demonstrate that the Ramsey policy is dynamically consistent even without commitment. We resolve the Ramsey problem and compare our results to those of Chamley on optimal capital income taxation.

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File URL: http://mpra.ub.uni-muenchen.de/9300/
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File URL: http://mpra.ub.uni-muenchen.de/10244/
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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 9300.

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Date of creation: 2008
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Handle: RePEc:pra:mprapa:9300

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Keywords: Inconsistency; Equilibrium policy; Optimal taxation;

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  1. V.V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991. "Optimal fiscal and monetary policy: some recent results," Proceedings, Federal Reserve Bank of Cleveland, pages 519-546.
  2. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimality of the Friedman Rule in Economies with Distorting Taxes," NBER Working Papers 4443, National Bureau of Economic Research, Inc.
  3. Avinash Dixit & Luisa Lambertini, 2003. "Interactions of Commitment and Discretion in Monetary and Fiscal Policies," American Economic Review, American Economic Association, vol. 93(5), pages 1522-1542, December.
  4. Judd, Kenneth L., 1999. "Optimal taxation and spending in general competitive growth models," Journal of Public Economics, Elsevier, vol. 71(1), pages 1-26, January.
  5. V. V. Chari & Patrick J Kehoe, 1998. "Sustainable Plans," Levine's Working Paper Archive 600, David K. Levine.
  6. Judd, Kenneth L., 1985. "Redistributive taxation in a simple perfect foresight model," Journal of Public Economics, Elsevier, vol. 28(1), pages 59-83, October.
  7. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  8. V. V. Chari & Patrick J. Kehoe, 1998. "Optimal fiscal and monetary policy," Staff Report 251, Federal Reserve Bank of Minneapolis.
  9. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  10. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
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Cited by:
  1. Arefiev, Nikolay & Baron, Tatyana, 2006. "Capital Taxation and Rent Seeking," MPRA Paper 9988, University Library of Munich, Germany.

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