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Uncertainty and the Design of Long-Run Fiscal Policy

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  • Alan J. Auerbach
  • Kevin A. Hassett

Abstract

This paper explores optimal fiscal policy in an overlapping-generations general-equilibrium model under uncertainty and the impact on optimal policy of the introduction of a type of policy stickiness intended to account for the stylized fact that major reforms happen infrequently. In general, our analysis suggests not only that action should not be delayed, but further that action should actually be accelerated. The added realism of restrictions on the frequency of policy changes alters this result in two ways. The prospect of being unable to set policy in the future occasions even more precautionary saving today, if the government acts. However, the government may also choose not to set policy, and its inaction range is very asymmetric. Because the impact of its policies on the current elderly cannot be reversed in the future, the government is much more likely to choose inaction when fiscal tightening is called for. Thus, the optimal policy response over time might best be characterized by great caution in general, but punctuated by occasional periods of apparent irresponsibility.

Suggested Citation

  • Alan J. Auerbach & Kevin A. Hassett, 1999. "Uncertainty and the Design of Long-Run Fiscal Policy," NBER Working Papers 7036, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:7036
    Note: PE EFG
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    File URL: http://www.nber.org/papers/w7036.pdf
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    References listed on IDEAS

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    1. repec:cdl:ucsbec:03-98 is not listed on IDEAS
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    4. Auerbach, Alan J. & Kotlikoff, Laurence J. & Leibfritz, Willi (ed.), 1999. "Generational Accounting around the World," National Bureau of Economic Research Books, University of Chicago Press, edition 1, number 9780226032139, December.
    5. Bernd Raffelhuschen & Laurence J. Kotlikoff, 1999. "Generational Accounting around the Globe," American Economic Review, American Economic Association, vol. 89(2), pages 161-166, May.
    6. Alan J. Auerbach & Laurence J. Kotlikoff & Willi Leibfritz, 1999. "Generational Accounting around the World," NBER Books, National Bureau of Economic Research, Inc, number auer99-1, May.
    7. repec:cdl:ucsbec:3-98 is not listed on IDEAS
    8. Peter Diamond, 2004. "Social Security," American Economic Review, American Economic Association, vol. 94(1), pages 1-24, March.
    9. Bohn, Henning, 1998. "Risk Sharing in a Stochastic Overlapping Generations Economy," University of California at Santa Barbara, Economics Working Paper Series qt9r2809f0, Department of Economics, UC Santa Barbara.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Auerbach, Alan J. & Gale, William G., 2000. "Perspectives on the Budget Surplus," National Tax Journal, National Tax Association;National Tax Journal, vol. 53(3), pages 459-472, September.
    2. Auerbach, Alan J. & Hassett, Kevin, 2007. "Optimal long-run fiscal policy: Constraints, preferences and the resolution of uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 31(5), pages 1451-1472, May.
    3. Kruse, Agneta, 2002. "Ageing Populations and Intergenerational Risk-sharing in PAYG Pension Schemes," Working Papers 2002:18, Lund University, Department of Economics.
    4. John Stephenson & Grant Scobie, 2002. "The Economics of Population Ageing," Treasury Working Paper Series 02/04, New Zealand Treasury.
    5. Jan Bonenkamp & Martijn van de Ven, 2006. "A small stochastic model of a pension fund with endogenous saving," CPB Memorandum 168, CPB Netherlands Bureau for Economic Policy Analysis.
    6. Kotlikoff, Laurence J., 2002. "Generational policy," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 4, chapter 27, pages 1873-1932, Elsevier.
    7. Mr. S. Nuri Erbas, 2002. "Primeron Reforms in a Second-Best Ambiguous Environment: A Case for Gradualism," IMF Working Papers 2002/050, International Monetary Fund.
    8. Henry J. Aaron, 2000. "Presidential address- Seeing through the fog," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 19(2), pages 193-206.
    9. Sally Wallace & James Alm, 2004. "The Jamaican Individual Income Tax," International Center for Public Policy Working Paper Series, at AYSPS, GSU paper0430, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.
    10. Lassila, Jukka & Valkonen, Tarmo, 2007. "Longevity Adjustment of Pension Benefits," Discussion Papers 1073, The Research Institute of the Finnish Economy.

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    More about this item

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus

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