IDEAS home Printed from https://ideas.repec.org/p/lie/wpaper/133.html
   My bibliography  Save this paper

Optimal Fiscal Policy under Endogenous Disaster Risk: How to Avoid Wars?

Author

Listed:
  • Vytautas Valaitis

    (University of Surrey)

  • Alessandro T. Villa

    (FRB Chicago)

Abstract

We examine the role of government investment in defense capital as a deterrence tool. Using an optimal fiscal policy framework with endogenous disaster risk, we allow for an endogenous determination of geopolitical risk and defense capacity, which we discipline using the Geopolitical Risk Index. We show both analytically and quantitatively that financing defense primarily through debt, rather than taxation, is optimal. Debt issuance mitigates present tax distortions but exacerbates them in the future, especially in wartime. However, since additional defense capital deters future wars, the expected tax distortions decline as well, making debt financing a welfare-improving strategy. Quantitatively, the optimal defense financing in the presence of heightened risk involves a twice higher share of debt and backloading of tax distortions compared to other types of government spending.

Suggested Citation

  • Vytautas Valaitis & Alessandro T. Villa, 2025. "Optimal Fiscal Policy under Endogenous Disaster Risk: How to Avoid Wars?," Bank of Lithuania Working Paper Series 133, Bank of Lithuania.
    • Handle: RePEc:lie:wpaper:133
    as

    Download full text from publisher

    File URL: https://www.lb.lt/uploads/publications/docs/51946_25be68336d349b70d0672c9067477894.pdf
    File Function: Full text
    Download Restriction: no
    ---><---

    More about this item

    Keywords

    Optimal Fiscal Policy; Incomplete Markets; Endogenous Disaster Risk.;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:lie:wpaper:133. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Aurelija Proskute (email available below). General contact details of provider: https://edirc.repec.org/data/lbanklt.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.