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Managing expectations and fiscal policy

  • 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
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Handle: RePEc:fip:fedawp:2009-29
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  7. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal fiscal policy in a business cycle model," Staff Report 160, Federal Reserve Bank of Minneapolis.
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