Asset Prices, Business Cycles, and Markov-Perfect Fiscal Policy when Agents are Risk-Sensitive
We study a business cycle model in which a benevolent fiscal authority must determine the optimal provision of government services, while lacking credibility, lump-sum taxes, and the ability to bond finance deficits. Households and the fiscal authority have risk sensitive preferences. We find that outcomes are affected importantly by the household’s risk sensitivity, but not by the fiscal authority’s. Further, while household risk-sensitivity induces a strong precautionary saving motive, which raises capital and lowers the return on assets, its effects on fluctuations and the business cycle are generally small, although more pronounced for negative shocks. Holding the stochastic steady state constant, increases in household risk-sensitivity lower the risk-free rate and raise the return on equity, increasing the equity premium. Finally, although risk-sensitivity has little effect on the provision of government services, it does cause the fiscal authority to lower the income tax rate. An additional contribution of this paper is to present a method for computing Markov-perfect equilibria in models where private agents and the government are risk-sensitive decision makers.
|Date of creation:||Oct 2013|
|Date of revision:|
|Contact details of provider:|| Postal: Crawford Building, Lennox Crossing, Building #132, Canberra ACT 2601|
Phone: +61 2 6125 4705
Fax: +61 2 6125 5448
Web page: http://cama.crawford.anu.edu.au
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Karantounias, Anastasios G., 2013. "Managing pessimistic expectations and fiscal policy," Theoretical Economics, Econometric Society, vol. 8(1), January.
- Steve Ambler & Alain Paquet, 1994.
"Recursive Methods for Computing Equilibria of General Equilibrium Dynamic Stackelberg Games,"
Cahiers de recherche CREFE / CREFE Working Papers
25, CREFE, Université du Québec à Montréal.
- Ambler, Steve & Paquet, Alain, 1997. "Recursive methods for computing equilibria of general equilibrium dynamic Stackelberg games," Economic Modelling, Elsevier, vol. 14(2), pages 155-173, April.
- Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
- Justin Svec, 2010.
"Optimal Fiscal Policy with Robust Control,"
1004, College of the Holy Cross, Department of Economics.
- Dominguez, Begona, 2007. "Public debt and optimal taxes without commitment," Journal of Economic Theory, Elsevier, vol. 135(1), pages 159-170, July.
- Salvador Ortigueira & Joana Pereira, 2007.
"Markov-Perfect Optimal Fiscal Policy: The Case of Unbalanced Budgets,"
Economics Working Papers
ECO2007/41, European University Institute.
- Pichler, Paul & Pereira, Joana & Ortigueira, Salvador, 2012. "Markov-perfect optimal fiscal policy : the case of unbalanced budgets," UC3M Working papers. Economics we1230, Universidad Carlos III de Madrid. Departamento de Economía.
- Niemann, Stefan & Pichler, Paul & Sorger, Gerhard, 2008. "Optimal Fiscal and Monetary Policy Without Commitment," Economics Discussion Papers 2897, University of Essex, Department of Economics.
- Sanjay K. Chugh, 2006.
"Optimal Fiscal and Monetary Policy with Sticky Wages and Sticky Prices,"
Review of Economic Dynamics,
Elsevier for the Society for Economic Dynamics, vol. 9(4), pages 683-714, October.
- Sanjay K. Chugh, 2005. "Optimal fiscal and monetary policy with sticky wages and sticky prices," International Finance Discussion Papers 834, Board of Governors of the Federal Reserve System (U.S.).
- Sanjay K. Chugh, 2006. "Optimal Fiscal and Monetary Policy with Sticky Wages and Sticky Prices," Computing in Economics and Finance 2006 228, Society for Computational Economics.
- Steve Ambler & Florian Pelgrin, 2007.
"Time-Consistent Control in Non-Linear Models,"
Staff Working Papers
07-3, Bank of Canada.
- Martin, Fernando M., 2010. "Markov-perfect capital and labor taxes," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 503-521, March.
- Thomas Tallarini, .
"Risk-Sensitive Real Business Cycles,"
GSIA Working Papers
1997-35, Carnegie Mellon University, Tepper School of Business.
- David R. Stockman, 2001. "Balanced-Budget Rules: Welfare Loss and Optimal Policies," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(2), pages 438-459, July.
- Hansen, Gary D., 1985.
"Indivisible labor and the business cycle,"
Journal of Monetary Economics,
Elsevier, vol. 16(3), pages 309-327, November.
- Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
- repec:esx:essedp:654 is not listed on IDEAS
- repec:esx:essedp:681 is not listed on IDEAS
- 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.
- Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
When requesting a correction, please mention this item's handle: RePEc:een:camaaa:2013-69. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Cama Admin)
If references are entirely missing, you can add them using this form.