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Tax Smoothing with Stochastic Interest Rates: A Reassessment of Clinton's Fiscal Legacy

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  • Lloyd-Ellis, Huw
  • Zhan, Shiqiang
  • Zhu, Xiaodong

Abstract

The return to "sound" fiscal policy after the high budget deficits of the 1980s and early 1990s has been hailed by many as the Clinton administration's most important achievement. We evaluate post-war, U.S. fiscal policy using a generalized tax-smoothing model that allows for stochastic interest rates and growth rates. We show that contrary to conventional wisdom, the evolution of the U.S. debt-GDP ratio during the 1980s was remarkably consistent with the tax-smoothing paradigm. In fact, a more substantial departure occurred during the late 1990s, when the debt-GDP ratio fell more rapidly than predicted by optimal tax smoothing.

Suggested Citation

  • Lloyd-Ellis, Huw & Zhan, Shiqiang & Zhu, Xiaodong, 2005. "Tax Smoothing with Stochastic Interest Rates: A Reassessment of Clinton's Fiscal Legacy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(4), pages 699-724, August.
    • Handle: RePEc:mcb:jmoncb:v:37:y:2005:i:4:p:699-724
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    Cited by:

    1. Luo, Yulei & Nie, Jun & Young, Eric R., 2014. "Model uncertainty and intertemporal tax smoothing," Journal of Economic Dynamics and Control, Elsevier, vol. 45(C), pages 289-314.
    2. Constantine Angyridis & Leo Michelis, 2021. "Structural breaks, debt limits and the tax smoothing hypothesis: theory and evidence from the OECD countries," Empirical Economics, Springer, vol. 60(3), pages 1283-1307, March.
    3. Angyridis, Constantine, 2009. "Balanced budget vs. Tax smoothing in a small open economy: A welfare comparison," Journal of Macroeconomics, Elsevier, vol. 31(3), pages 438-463, September.
    4. Emilio Congregado & Vicente Esteve & Juan A. María A. Prats, 2024. "Optimal public deficit and tax-smoothing in the Spanish economy, 1850-2022," Working Papers 2401, Department of Applied Economics II, Universidad de Valencia.
    5. Mr. Evan C Tanner, 2013. "Fiscal Sustainability: A 21st Century Guide for the Perplexed," IMF Working Papers 2013/089, International Monetary Fund.

    More about this item

    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • F3 - International Economics - - International Finance
    • H6 - Public Economics - - National Budget, Deficit, and Debt

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