The Welfare Costs of Fiscal Uncertainty: a Quantitative Evaluation

This paper quantifies the distributional costs of fiscal uncertainty in a neoclassical stochastic growth environment. We set up an incomplete-market model where heterogeneous households face uninsurable idiosyncratic risks in the processes of labor income and discount factor. Aggregate uncertainty arises from both productivity and fiscal spending shocks. Starting from an initial situation calibrated to U.S. wealth inequality and aggregate as well as idiosyncratic shocks, we evaluate the general equilibrium consequences of eliminating fiscal spending shocks, while keeping the aggregate productivity process intact. We conduct comparisons along the transition path, and present the distributional consequences of eliminating fiscal uncertainty across wealth, employment status, and preference dimensions. The extensions to the baseline analysis include the investigation of alternative roles of government spending, an evaluation of welfare consequences under balanced budget fiscal rule, and an analysis of the sudden policy change and extreme fiscal uncertainty.