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Fiscal Policy in Debt Constrained Economies

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  • Manuel Amador

    (Stanford University)

  • Mark Aguiar

    (University of Rochester)

Abstract

We study optimal fiscal policy in a small open economy (SOE) with sovereign and private default risk. The SOE's government uses linear taxation to fund exogenous expenditures and uses public debt to inter-temporally allocate tax distortions. We characterize a class of environments in which the tax on labor goes to zero in the long run, while the tax on capital income may be non-zero,reversing the standard prediction of the Ramsey tax literature. The zero labor tax is an optimal long run outcome if the private agents are impatient relative to the international interest rate and the economy is subject to private and/or sovereign debt constraints. We show that a similar result holds in a closed economy with imperfect inter-generational altruism.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 527.

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Date of creation: 2011
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Handle: RePEc:red:sed011:527

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References

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  1. Daron Acemoglu & Mikhail Golosov & Aleh Tsyvinski, 2007. "Political Economy of Mechanisms," Levine's Bibliography 321307000000000886, UCLA Department of Economics.
  2. Mark Aguiar & Manuel Amador, 2009. "Growth in the Shadow of Expropriation," Discussion Papers 08-051, Stanford Institute for Economic Policy Research.
  3. Acemoglu, Daron & Golosov, Mikhail & Tsyvinski, Aleh, 2011. "Political economy of Ramsey taxation," Journal of Public Economics, Elsevier, vol. 95(7-8), pages 467-475, August.
  4. 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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  6. Jones, Larry E. & Manuelli, Rodolfo E. & Rossi, Peter E., 1997. "On the Optimal Taxation of Capital Income," Journal of Economic Theory, Elsevier, vol. 73(1), pages 93-117, March.
  7. Stephen Coate & Marco Battaglini, 2007. "A Dynamic Theory of Public Spending, Taxation and Debt," 2007 Meeting Papers 573, Society for Economic Dynamics.
  8. Timothy J Kehoe & David K Levine, 1993. "Debt Constrained Asset Markets," Levine's Working Paper Archive 1276, David K. Levine.
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  10. Mark Aguiar & Manuel Amador & Gita Gopinath, 2007. "Investment Cycles and Sovereign Debt Overhang," NBER Working Papers 13353, National Bureau of Economic Research, Inc.
  11. Dominguez, Begona, 2007. "Public debt and optimal taxes without commitment," Journal of Economic Theory, Elsevier, vol. 135(1), pages 159-170, July.
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  13. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  14. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973.
  15. Emmanuel Farhi & Iván Werning, 2007. "Inequality and Social Discounting," Journal of Political Economy, University of Chicago Press, vol. 115, pages 365-402.
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Cited by:
  1. repec:hal:wpaper:halshs-00662513 is not listed on IDEAS
  2. Gabrielle Demange, 2012. "Contagion in financial networks: a threat index," PSE Working Papers halshs-00662513, HAL.
  3. Das, Debasish Kumar, 2012. "Determinants of current account imbalances in the global economy: A dynamic panel analysis," MPRA Paper 42419, University Library of Munich, Germany.

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