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Markov-perfect optimal fiscal policy : the case of unbalanced budgets

  • Salvador Ortigueira


  • Joana Pereira


  • Paul Pichler


We study optimal time-consistent fiscal policy in a neoclassical economy with endogenous government spending, physical capital and public debt. We show that a dynamic complementarity between the households’ consumption-savings decision and the government’s policy decision gives rise to a multiplicity of expectations-driven Markov-perfect equilibria. The long-run levels of taxes, government spending and debt are not uniquely pinned down by economic fundamentals, but are determined by expectations over current and future policies. Accordingly, economies with identical fundamentals may significantly differ in their levels of public indebtedness

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Paper provided by Universidad Carlos III, Departamento de Economía in its series Economics Working Papers with number we1230.

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Date of creation: Oct 2012
Date of revision:
Handle: RePEc:cte:werepe:we1230
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  1. repec:oup:restud:v:75:y:2008:i:3:p:789-808 is not listed on IDEAS
  2. Salvador Ortigueira, 2006. "Markov-Perfect Optimal Taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(1), pages 153-178, January.
  3. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  4. Fernando M. Martin, 2004. "A Positive Theory of Government Debt," Macroeconomics 0408013, EconWPA, revised 12 Oct 2004.
  5. Zheng Song, 2009. "Rotten Parents and Disciplined Children: A Politico-Economic Theory of Public Expenditure and Debt," 2009 Meeting Papers 94, Society for Economic Dynamics.
  6. Paul Klein & JosÈ-VÌctor RÌos-Rull, 2003. "Time-consistent optimal fiscal policy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(4), pages 1217-1245, November.
  7. Javier Díaz-Giménez & Giorgia Giovanetti & Ramon Marimon & Pedro Teles, 2003. "Nominal Debt as a Burden on Monetary Policy," Working Papers 8, Barcelona Graduate School of Economics.
  8. Andrew Blake & Tatiana Kirsanova, 2008. "Discretionary Policy and Multiple Equilibria in LQ RE Models," Discussion Papers 0813, Exeter University, Department of Economics.
  9. Kenneth L. Judd, 1982. "Redistributive Taxation in a Simple Perfect Foresight Model," Discussion Papers 572, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  10. Stefania Albanesi & V.V.Chari & Lawrence J. Christiano, 2002. "Expectation traps and monetary policy," Working Paper Series WP-02-04, Federal Reserve Bank of Chicago.
  11. Davide Debortoli & Ricardo Nunes, 2013. "Lack Of Commitment And The Level Of Debt," Journal of the European Economic Association, European Economic Association, vol. 11(5), pages 1053-1078, October.
  12. Robert G. King & Alexander L. Wolman, 2004. "Monetary discretion, pricing complementarity, and dynamic multiple equilibria," Working Paper 04-05, Federal Reserve Bank of Richmond.
  13. Per Krusell & Fernando M. Martin & Jose-Victor Rios-Rull, 2006. "Time Consistent Debt," 2006 Meeting Papers 210, Society for Economic Dynamics.
  14. Judd, Kenneth L., 1992. "Projection methods for solving aggregate growth models," Journal of Economic Theory, Elsevier, vol. 58(2), pages 410-452, December.
  15. Persson, Mats & Persson, Torsten & Svensson, Lars E O, 1987. "Time Consistency of Fiscal and Monetary Policy," Econometrica, Econometric Society, vol. 55(6), pages 1419-31, November.
  16. Reis, Catarina, 2006. "Taxation without Commitment," MPRA Paper 2071, University Library of Munich, Germany.
  17. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  18. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711, June.
  19. Jorge Soares, Marina Azzimonti, Pierre-Daniel Sarte & Pierre-Daniel Sarte & Jorge Soares, 2006. "Optimal Policy and (the Lack of) Time Inconsistency: Insights from Simple Models," Working Papers 06-08, University of Delaware, Department of Economics.
  20. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-61, September.
  21. Dominguez, Begona, 2007. "Public debt and optimal taxes without commitment," Journal of Economic Theory, Elsevier, vol. 135(1), pages 159-170, July.
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