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Time‐consistent optimal fiscal policy over the business cycle

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  • Zhigang Feng

Abstract

This paper examines a dynamic stochastic economy with a benevolent government that cannot commit to its future policies. I consider equilibria that are time‐consistent and allow for history‐dependent strategies. A new numerical algorithm is developed to solve for the set of equilibrium payoffs. For a baseline economy calibrated to the U.S. economy, the capital income tax with the highest social welfare is slightly procyclical, while the labor income tax is countercyclical. Compared with the data, this equilibrium provides a better account of the cyclical properties of U.S. tax policy than other solutions that abstract from history dependence. The welfare cost of no commitment is about 0.22% of aggregate consumption as compared to the Ramsey allocation with full commitment.

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  • Zhigang Feng, 2015. "Time‐consistent optimal fiscal policy over the business cycle," Quantitative Economics, Econometric Society, vol. 6(1), pages 189-221, March.
    • Handle: RePEc:wly:quante:v:6:y:2015:i:1:p:189-221
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    Cited by:

    1. Zhigang Feng & Jianjun Miao & Adrian Peralta‐Alva & Manuel S. Santos, 2014. "Numerical Simulation Of Nonoptimal Dynamic Equilibrium Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 55(1), pages 83-110, February.
    2. Ateşağaoğlu, Orhan Erem & Torul, Orhan, 2018. "Optimal Ramsey taxation with endogenous risk aversion," Economics Letters, Elsevier, vol. 171(C), pages 87-92.
    3. Rüdiger Bachmann & Jinhui H. Bai, 2013. "Public consumption over the business cycle," Quantitative Economics, Econometric Society, vol. 4(3), pages 417-451, November.
    4. Kang, Minwook & Kim, Eungsik, 2023. "A government policy with time-inconsistent consumers," Journal of Economic Behavior & Organization, Elsevier, vol. 214(C), pages 44-67.
    5. Kam, Timothy & Stauber, Ronald, 2016. "Solving dynamic public insurance games with endogenous agent distributions: Theory and computational approximation," Journal of Mathematical Economics, Elsevier, vol. 64(C), pages 77-98.

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