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Politically Optimal Fiscal Policy

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  • Irina Yakadina
  • Michael Kumhof

Abstract

Why do governments issue large amounts of debt? In what sense and for whom is such a policy optimal? We show that twisting the optimal taxation paradigm produces very reasonable predictions for debt and real interest rates. Adding an extra dimension of uncertainty about the political planning horizon gives rise to a positive and very plausible government debt-to-GDP ratio of about 55 percent in a model that otherwise predicts negative government debt. We quantify the impact of political uncertainty on steady state and business cycle dynamics. We illustrate how populist tax cuts can cause business cycle fluctuations.

Suggested Citation

  • Irina Yakadina & Michael Kumhof, 2007. "Politically Optimal Fiscal Policy," IMF Working Papers 07/68, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:07/68
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    Cited by:

    1. Marina Azzimonti, 2015. "The dynamics of public investment under persistent electoral advantage," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(3), pages 653-678, July.
    2. Paolo Biraschi, "undated". "Searching for the optimal EMU fiscal rule:an ex-post analysis of the SGP reform proposals," Working Papers wp2008-7, Department of the Treasury, Ministry of the Economy and of Finance.
    3. Rieth, Malte, 2014. "Myopic governments and welfare-enhancing debt limits," Journal of Economic Dynamics and Control, Elsevier, vol. 38(C), pages 250-265.
    4. Marina Azzimonti, 2015. "The dynamics of public investment under persistent electoral advantage," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(3), pages 653-678, July.
    5. repec:eee:dyncon:v:85:y:2017:i:c:p:1-20 is not listed on IDEAS

    More about this item

    Keywords

    Business cycles; Fiscal policy; Gross domestic product; Political economy; Public debt; Tax changes; Optimal Fiscal Policy; Incomplete Asset Markets; Government Debt Bias; taxation; government spending; equation; equations; Fiscal Policies and Behavior of Economic Agents: Other;

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