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: |
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.:
- Steven Ambler & Florian Pelgrin, 2005.
"Time Consistent Control in Non-Linear Models,"
Computing in Economics and Finance 2005
282, Society for Computational Economics.
- 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.
- 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.).
- 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.
- Stefan Niemann & Paul Pichler & Gerhard Sorger, 2008. "Optimal Fiscal and Monetary Policy Without Commitment," Economics Discussion Papers 654, University of Essex, 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.
- TallariniJr., Thomas D., 2000.
"Risk-sensitive real business cycles,"
Journal of Monetary Economics,
Elsevier, vol. 45(3), pages 507-532, June.
- Robert E. Lucas Jr. & Nancy L. Stokey, 1982.
"Optimal Fiscal and Monetary Policy in an Economy Without Capital,"
532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- 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.
- Ambler, Steve & Paquet, Alain, 1997.
"Recursive methods for computing equilibria of general equilibrium dynamic Stackelberg games,"
Elsevier, vol. 14(2), pages 155-173, April.
- 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.
- Gary Hansen, 2010.
"Indivisible Labor and the Business Cycle,"
Levine's Working Paper Archive
233, David K. Levine.
- Salvador Ortigueira & Joana Pereira, 2007.
"Markov-Perfect Optimal Fiscal Policy: The Case of Unbalanced Budgets,"
Economics Working Papers
ECO2007/41, European University Institute.
- Salvador Ortigueira & Joana Pereira & Paul Pichler, 2012. "Markov-perfect optimal fiscal policy : the case of unbalanced budgets," Economics Working Papers we1230, Universidad Carlos III, Departamento de Economía.
- Svec, Justin, 2012.
"Optimal fiscal policy with robust control,"
Journal of Economic Dynamics and Control,
Elsevier, vol. 36(3), pages 349-368.
- Thomas J. Sargent & Riccardo Colacito & Lars P. Hansen & Timothy Cogley, 2008. "Robustness and US Monetary," 2008 Meeting Papers 228, Society for Economic Dynamics.
- Karantounias, Anastasios G., 2013. "Managing pessimistic expectations and fiscal policy," Theoretical Economics, Econometric Society, vol. 8(1), January.
- Stefan Niemann & Paul Pichler & Gerhard Sorger, 2009. "Inflation dynamics under optimal discretionary fiscal and monetary policies," Economics Discussion Papers 681, University of Essex, Department of Economics.
- 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.
- 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.
- Mariano M. Croce, 2006. "Welfare Costs, Long Run Consumption Risk, and a Production Economy," 2006 Meeting Papers 582, Society for Economic Dynamics.
- Martin, Fernando M., 2010. "Markov-perfect capital and labor taxes," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 503-521, March.
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.