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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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  1. Caballero, Ricardo J & Farhi, Emmanuel & Gourinchas, Pierre-Olivier, 2006. "An Equilibrium Model of "Global Imbalances" and Low Interest Rates," Center for International and Development Economics Research, Working Paper Series, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkele qt7xc0g8mm, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
  2. Jones, Larry E. & Manuelli, Rodolfo E. & Rossi, Peter E., 1997. "On the Optimal Taxation of Capital Income," Journal of Economic Theory, Elsevier, Elsevier, vol. 73(1), pages 93-117, March.
  3. Daron Acemoglu & Michael Golosov & Aleh Tsyvinski, 2008. "Political Economy of Mechanisms," Econometrica, Econometric Society, Econometric Society, vol. 76(3), pages 619-641, 05.
  4. Marco Battaglini & Stephen Coate, 2008. "A Dynamic Theory of Public Spending, Taxation, and Debt," American Economic Review, American Economic Association, American Economic Association, vol. 98(1), pages 201-36, March.
  5. Mark Aguiar & Manuel Amador, 2009. "Growth in the Shadow of Expropriation," NBER Working Papers 15194, National Bureau of Economic Research, Inc.
  6. 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, University of Chicago Press, vol. 110(6), pages 1220-1254, December.
  7. Timothy J Kehoe & David K Levine, 1993. "Debt Constrained Asset Markets," Levine's Working Paper Archive 1276, David K. Levine.
  8. Benhabib, Jess & Rustichini, Aldo, 1997. "Optimal Taxes without Commitment," Journal of Economic Theory, Elsevier, Elsevier, vol. 77(2), pages 231-259, December.
  9. Rustichini, A., 1998. "Lagrange multipliers in incentive-constrained problems," Journal of Mathematical Economics, Elsevier, vol. 29(4), pages 365-380, May.
  10. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, Econometric Society, vol. 54(3), pages 607-22, May.
  11. Mark Aguiar & Manuel Amador & Gita Gopinath, 2007. "Investment Cycles and Sovereign Debt Overhang," NBER Working Papers 13353, National Bureau of Economic Research, Inc.
  12. Kenneth L. Judd, 1982. "Redistributive Taxation in a Simple Perfect Foresight Model," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 572, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  13. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 87(5), pages 940-71, October.
  14. Daron Acemoglu & Mikhail Golosov & Aleh Tsyvinski, 2009. "Political Economy of Ramsey Taxation," NBER Working Papers 15302, National Bureau of Economic Research, Inc.
  15. Dominguez, Begona, 2007. "Public debt and optimal taxes without commitment," Journal of Economic Theory, Elsevier, Elsevier, vol. 135(1), pages 159-170, July.
  16. Debraj Ray, 2002. "The Time Structure of Self-Enforcing Agreements," Econometrica, Econometric Society, Econometric Society, vol. 70(2), pages 547-582, March.
  17. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, Princeton University Press, edition 1, volume 1, number 8973.
  18. Emmanuel Farhi & Iván Werning, 2007. "Inequality and Social Discounting," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 115, pages 365-402.
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Cited by:
  1. 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.
  2. repec:hal:wpaper:halshs-00662513 is not listed on IDEAS
  3. Demange, Gabrielle, 2012. "Contagion in financial networks: A threat index," CEPR Discussion Papers, C.E.P.R. Discussion Papers 8793, C.E.P.R. Discussion Papers.

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