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Optimal Fiscal Policy with Recursive Preferences

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I study the implications of recursive utility, a popular preference specification in macrofinance, for the design of optimal fiscal policy. Standard Ramsey tax-smoothing prescriptions are substantially altered. The planner overinsures by taxing less in bad times and more in good times, mitigating the effects of shocks. At the intertemporal margin, there is a novel incentive for introducing distortions that can lead to an ex-ante capital subsidy. Overall, optimal policy calls for a much stronger use of debt returns as a fiscal absorber, leading to the conclusion that actual fiscal policy is even worse than we thought.

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  • Karantounias, Anastasios G., 2013. "Optimal Fiscal Policy with Recursive Preferences," FRB Atlanta Working Paper 2013-07, Federal Reserve Bank of Atlanta, revised 01 Jan 2018.
  • Handle: RePEc:fip:fedawp:2013-07
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Anthony Diercks, 2016. "The Equity Premium, Long-Run Risk, and Optimal Monetary Policy," 2016 Meeting Papers 207, Society for Economic Dynamics.
    2. Benigno, Pierpaolo & Paciello, Luigi, 2014. "Monetary policy, doubts and asset prices," Journal of Monetary Economics, Elsevier, pages 85-98.
    3. Karen Kopecky & Anastasios Karantounias, 2015. "Optimal time-consistent taxation with default," 2015 Meeting Papers 1297, Society for Economic Dynamics.
    4. Piero Gottardi & Atsushi Kajii & Tomoyuki Nakajima, 2015. "Optimal Taxation and Debt with Uninsurable Risks to Human Capital Accumulation," American Economic Review, American Economic Association, pages 3443-3470.
    5. Hengjie Ai & Ravi Bansal, 2016. "Risk Preferences and The Macro Announcement Premium," NBER Working Papers 22527, National Bureau of Economic Research, Inc.
    6. Seneca, Martin, 2016. "Risk shocks close to the zero lower bound," Bank of England working papers 606, Bank of England.

    More about this item

    Keywords

    Ramsey plan; tax smoothing; Epstein-Zin; recursive utility; excess burden; labor tax; capital tax; martingale; fiscal insurance;

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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