How to Deal with Increased Public Debt

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How to Deal with Increased Public Debt

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Michal Horvath ()

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Michal Horvath

Abstract

We compare optimal fiscal policy strategies under alternative perspectives on optimality with the aim to contribute to current policy discussions as well as to the historical debate on optimal tax dynamics. We show that a strategy of slow unwinding of increases in public debt and taxes following structural shocks is consistent with the unconditionally optimal policy in a New Keynesian framework with nominal rigidity and distortionary taxes. This contrasts with the emerging consensus derived in similar frameworks from welfare objectives defined over conditional expectations, recommending permanent level shifts in debt and taxes.

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Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 0607.

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Date of creation: Jun 2006
Date of revision: Jun 2009
Handle: RePEc:san:cdmawp:0607

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Find related papers by JEL classification:
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis
E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization

This paper has been announced in the following NEP Reports:

NEP-ALL-2006-07-09 (All new papers)
NEP-CBA-2006-07-09 (Central Banking)
NEP-MAC-2006-07-09 (Macroeconomics)
NEP-MON-2006-07-09 (Monetary Economics)
NEP-PBE-2006-07-09 (Public Economics)

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