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Optimal Fiscal Policy with Heterogeneous Agents and Aggregate Shocks

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  • Xavier Ragot

    (Sciencespo)

  • Francois Le Grand

    (EMLyon Business School)

Abstract

We show that allocations in incomplete insurance-market economies can be represented as the solution of the program of a constrained planner. This representation allows for solving Ramsey programs in incomplete-market economies with aggregate shocks. We apply this framework to derive optimal fiscal policy and public debt dynamics in an economy with capital after persistent technology shocks, when the planner can use distorting taxes on capital and labor and positive lump-sum transfers. Average capital taxation is a simple function of the tightness of credit constraints. In a quantitative exercise, it is shown that private savings increase too much after a technology shock, and are absorbed by an increase in public debt and a decrease in capital taxes. Simulations of these optimal solutions can be obtained by simple perturbation methods.

Suggested Citation

  • Xavier Ragot & Francois Le Grand, 2017. "Optimal Fiscal Policy with Heterogeneous Agents and Aggregate Shocks," 2017 Meeting Papers 969, Society for Economic Dynamics.
  • Handle: RePEc:red:sed017:969
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    File URL: https://economicdynamics.org/meetpapers/2017/paper_969.pdf
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    References listed on IDEAS

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    3. Robert E. Hall, 2010. "Basic Analysis of Forward-Looking Decision Making," Introductory Chapters,in: Forward-Looking Decision Making: Dynamic Programming Models Applied to Health, Risk, Employment, and Financial Stability Princeton University Press.
    4. Kubler, Felix & Schmedders, Karl, 2002. "Recursive Equilibria In Economies With Incomplete Markets," Macroeconomic Dynamics, Cambridge University Press, vol. 6(02), pages 284-306, April.
    5. Sebastian Dyrda & Marcelo Pedroni, 2015. "Optimal Fiscal Policy in a Model with Uninsurable Idiosyncratic Shocks," Working Papers tecipa-550, University of Toronto, Department of Economics.
    6. Edouard Challe & Julien Matheron & Xavier Ragot & Juan F. Rubio‚ÄźRamirez, 2017. "Precautionary saving and aggregate demand," Quantitative Economics, Econometric Society, vol. 8(2), pages 435-478, July.
    7. Golosov, M. & Tsyvinski, A. & Werquin, N., 2016. "Recursive Contracts and Endogenously Incomplete Markets," Handbook of Macroeconomics, Elsevier.
    8. Krusell, Per & Mukoyama, Toshihiko & Smith Jr., Anthony A., 2011. "Asset prices in a Huggett economy," Journal of Economic Theory, Elsevier, vol. 146(3), pages 812-844, May.
    9. Greg Kaplan & Giovanni L. Violante, 2014. "A Model of the Consumption Response to Fiscal Stimulus Payments," Econometrica, Econometric Society, vol. 82(4), pages 1199-1239, July.
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