Optimal Fiscal Policy for Protecting Future Generations

We study the design of fiscal policy within a two-period model involving a central government and multiple regions that differ in the privately observable durability of their local intergenerational public goods (IPG). The IPG is fi- nanced through local debt and fiscal transfers, and the regions are less patient than the central government. We address the joint frictions of asymmetric information and present bias. We find that regions with greater durability should be allocated higher levels of debt issuance, regardless of the presence of informational friction. Regarding the endogenous interaction between these two fiscal policies, our analysis indicates that, with a power utility function, debt issuance and fiscal transfers function as complementary tools in the first- best optimum. However, when accounting for these two frictions, resources should be transferred from regions with higher durability to those with lower durability, suggesting that debt issuance and fiscal transfers act as substitutes in restoring social optimality.