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Managing expectations and fiscal policy

Listed author(s):
  • Anastasios G. Karantounias with Lars Peter Hansen
  • Thomas J. Sargent

This paper studies an optimal fiscal policy problem of Lucas and Stokey (1983) but in a situation in which the representative agent's distrust of the probability model for government expenditures puts model uncertainty premia into history-contingent prices. This situation gives rise to a motive for expectation management that is absent within rational expectations and a novel incentive for the planner to smooth the shadow value of the agent's subjective beliefs to manipulate the equilibrium price of government debt. Unlike the Lucas and Stokey (1983) model, the optimal allocation, tax rate, and debt become history dependent despite complete markets and Markov government expenditures.

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Paper provided by Federal Reserve Bank of Atlanta in its series FRB Atlanta Working Paper with number 2009-29.

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Date of creation: 2009
Handle: RePEc:fip:fedawp:2009-29
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  1. Thomas Tallarini, "undated". "Risk-Sensitive Real Business Cycles," GSIA Working Papers 1997-35, Carnegie Mellon University, Tepper School of Business.
  2. Marco Battaglini & Stephen Coate, 2007. "A Dynamic Theory of Public Spending, Taxation and Debt," Discussion Papers 1441, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. Lars Hansen & Thomas Sargent & Thomas Tallarini, "undated". "Robust Permanent Income and Pricing," GSIA Working Papers 1997-51, Carnegie Mellon University, Tepper School of Business.
  4. Albert Marcet & Ramon Marimon, 2011. "Recursive Contracts," CEP Discussion Papers dp1055, Centre for Economic Performance, LSE.
  5. Albert Marcet & Thomas J. Sargent & Juha Seppala, 1996. "Optimal taxation without state-contingent debt," Economics Working Papers 170, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2001.
  6. 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.
  7. Strzalecki, Tomasz, 2011. "Axiomatic Foundations of Multiplier Preferences," Scholarly Articles 14397610, Harvard University Department of Economics.
  8. Chari, V V & Christiano, Lawrence J & Kehoe, Patrick J, 1994. "Optimal Fiscal Policy in a Business Cycle Model," Journal of Political Economy, University of Chicago Press, vol. 102(4), pages 617-652, August.
  9. Brunnermeier, Markus & Gollier, Christian & Parker, Jonathan, 2007. "Optimal Beliefs, Asset Prices, and the Preference for Skewed Returns," IDEI Working Papers 429, Institut d'Économie Industrielle (IDEI), Toulouse.
  10. Buera, Francisco & Nicolini, Juan Pablo, 2004. "Optimal maturity of government debt without state contingent bonds," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 531-554, April.
  11. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  12. Emmanuel Farhi & Iván Werning, 2008. "Optimal Savings Distortions with Recursive Preferences," NBER Working Papers 13720, National Bureau of Economic Research, Inc.
  13. Anderson, Evan W., 2005. "The dynamics of risk-sensitive allocations," Journal of Economic Theory, Elsevier, vol. 125(2), pages 93-150, December.
  14. Ricardo J. Caballero & Arvind Krishnamurthy, 2008. "Collective Risk Management in a Flight to Quality Episode," Journal of Finance, American Finance Association, vol. 63(5), pages 2195-2230, October.
  15. Albert Marcet & Albert Scott, 2003. "Debt and Deficit Fluctuations and the Structure of Bond Markets," Working Papers 171, Barcelona Graduate School of Economics.
  16. Fabio Maccheroni & Massimo Marinacci & Aldo Rustichini, 2006. "Ambiguity Aversion, Robustness, and the Variational Representation of Preferences," Econometrica, Econometric Society, vol. 74(6), pages 1447-1498, November.
  17. George-Marios Angeletos, 2002. "Fiscal Policy with Noncontingent Debt and the Optimal Maturity Structure," The Quarterly Journal of Economics, Oxford University Press, vol. 117(3), pages 1105-1131.
  18. Sleet, Christopher & Yeltekin, Sevin, 2006. "Optimal taxation with endogenously incomplete debt markets," Journal of Economic Theory, Elsevier, vol. 127(1), pages 36-73, March.
  19. Anastasios G. Karantounias, 2009. "Ramsey Taxation and fear of misspecification," 2009 Meeting Papers 822, Society for Economic Dynamics.
  20. Harald Uhlig, 2009. "A Model of a Systemic Bank Run," Working Papers 2009-006, Becker Friedman Institute for Research In Economics.
  21. Hansen, Lars Peter & Sargent, Thomas J., 2005. "Robust estimation and control under commitment," Journal of Economic Theory, Elsevier, vol. 124(2), pages 258-301, October.
  22. Hansen, Lars Peter & Heaton, John & Lee, Junghoon & Roussanov, Nikolai, 2007. "Intertemporal Substitution and Risk Aversion," Handbook of Econometrics, in: J.J. Heckman & E.E. Leamer (ed.), Handbook of Econometrics, edition 1, volume 6, chapter 61 Elsevier.
  23. Zhu, Xiaodong, 1992. "Optimal fiscal policy in a stochastic growth model," Journal of Economic Theory, Elsevier, vol. 58(2), pages 250-289, December.
  24. 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 937-969, July.
  25. Chang, Roberto, 1998. "Credible Monetary Policy in an Infinite Horizon Model: Recursive Approaches," Journal of Economic Theory, Elsevier, vol. 81(2), pages 431-461, August.
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