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The determination of public debt under both aggregate and idiosyncratic uncertainty

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  • Chien, YiLi
  • Wen, Yi

Abstract

We use an analytically tractable, heterogeneous-agent incomplete-markets model to show that the Ramsey planner's decision to finance stochastic public expenditures implies a departure from tax smoothing and an endogenous mean-reverting force to support positive debt growth despite the government's precautionary saving motives. Specifically, the government's attempt to balance the competing incentives between its own precautionary saving (tax smoothing) and households' precautionary saving (individual consumption smoothing)—even at the cost of extra tax distortion—implies an endogenous, soft lower bound on the stochastic unit-root dynamics of optimal taxes and public debt.

Suggested Citation

  • Chien, YiLi & Wen, Yi, 2022. "The determination of public debt under both aggregate and idiosyncratic uncertainty," Journal of Economic Theory, Elsevier, vol. 203(C).
    • Handle: RePEc:eee:jetheo:v:203:y:2022:i:c:s0022053122000643
    DOI: 10.1016/j.jet.2022.105474
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    Cited by:

    1. Chen, Yunmin & Chien, YiLi & Wen, Yi & Yang, C.C., 2021. "Are unconditional lump-sum transfers a good idea?," Economics Letters, Elsevier, vol. 209(C).
    2. YiLi Chien & Yi Wen & HsinJung Wu, 2020. "Are Government Bonds Net Wealth or a Liability? ---Optimal Debt and Taxes in an OLG Model with Uninsurable Income Risk," Working Papers 2020-007, Federal Reserve Bank of St. Louis, revised 03 Jan 2021.
    3. Chien, YiLi & Wen, Yi, 2023. "Optimal fiscal policy under capital overaccumulation," Macroeconomic Dynamics, Cambridge University Press, vol. 27(6), pages 1706-1736, September.
    4. Chien, YiLi & Wen, Yi, 2021. "Time-inconsistent optimal quantity of debt," European Economic Review, Elsevier, vol. 140(C).
    5. Tran-Xuan, Monica, 2023. "Optimal redistributive policy in debt constrained economies," Journal of International Economics, Elsevier, vol. 144(C).

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    More about this item

    Keywords

    Optimal public debt; Tax smoothing; Ramsey problem; Incomplete markets;
    All these keywords.

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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