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Optimal fiscal policy under learning

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  • Caprioli, Francesco

Abstract

This paper characterizes optimal fiscal policy when agents learn about future taxation. A benevolent and fully rational government chooses taxes on labor income and state-contingent bonds to finance public spending, considering that private agents form their expectations through a learning algorithm. Facing a trade-off between distortionary taxes and distorted expectations, the Ramsey planner chooses the policy that minimizes the total cost of distortions. The analysis produces two main results. First, the government will use fiscal variables to manipulate expectations, reducing taxes and issuing debt at times of pessimism and doing the opposite at times of optimism. This speeds up learning. Second, the expectation-dependent fiscal plan is also history-dependent, and it prescribes taxes that are not as smooth and more persistent than under rational expectations. These findings are robust to alternative learning algorithms.

Suggested Citation

  • Caprioli, Francesco, 2015. "Optimal fiscal policy under learning," Journal of Economic Dynamics and Control, Elsevier, vol. 58(C), pages 101-124.
  • Handle: RePEc:eee:dyncon:v:58:y:2015:i:c:p:101-124
    DOI: 10.1016/j.jedc.2015.05.008
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    Cited by:

    1. repec:spr:joecth:v:64:y:2017:i:1:d:10.1007_s00199-016-0980-5 is not listed on IDEAS
    2. Hollmayr, Josef & Matthes, Christian, 2015. "Learning about fiscal policy and the effects of policy uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 59(C), pages 142-162.

    More about this item

    Keywords

    Optimal fiscal policy; Adaptive learning;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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