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Time Consistency Of Optimal Fiscal Policy In An Endogenous Growth Model

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  • Begoa Domnguez Manzano

    (Universitat Autnoma de Barcelona)

Abstract

The present paper analyses the time-consistency of optimal fiscal policies in a model with private capital and endogenous growth achieved via public capital. A benevolent government chooses both public spending and taxation plans in order to maximise the welfare of the representative individual. When a full-commitment technology is assumed, the optimal policy is obviously implementable. Nevertheless, in the absence of full-commitment, it is well known that the debt restructuring method cannot make the optimal fiscal policy time-consistent in economies with private capital. Under a zero-tax rate on capital income, we prove that debt restructuring can solve the time-inconsistency problem of fiscal policy. In order to compare this policy with the one under full-commitment, we use a numerical solution method for non-linear rational expectations models, in particular the eigenvalue-eigenvector decomposition method suggested by Novales et al. (1999), which in turn is based on Sims (1998). Both models are solved and surprisingly we find that the policy under debt-commitment is quite close to the full-commitment policy both in growth and in welfare terms.

Suggested Citation

  • Begoa Domnguez Manzano, 2000. "Time Consistency Of Optimal Fiscal Policy In An Endogenous Growth Model," Computing in Economics and Finance 2000 69, Society for Computational Economics.
  • Handle: RePEc:sce:scecf0:69
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    References listed on IDEAS

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    1. Persson, Mats & Persson, Torsten & Svensson, Lars E O, 1987. "Time Consistency of Fiscal and Monetary Policy," Econometrica, Econometric Society, vol. 55(6), pages 1419-1431, November.
    2. Chari, V V & Christiano, Lawrence J & Kehoe, Patrick J, 1994. "Optimal Fiscal Policy in a Business Cycle Model," Journal of Political Economy, University of Chicago Press, vol. 102(4), pages 617-652, August.
    3. Aschauer, David Alan, 1989. "Is public expenditure productive?," Journal of Monetary Economics, Elsevier, vol. 23(2), pages 177-200, March.
    4. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-622, May.
    5. Faig, Miquel, 1994. "Debt Restructuring and the Time Consistency of Optimal Policies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(2), pages 171-181, May.
    6. Barro, Robert J, 1990. "Government Spending in a Simple Model of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages 103-126, October.
    7. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
    8. Faig, Miquel, 1991. " Time Inconsistency, Capital Mobility and Debt Restructuring in a Small Open Economy," Scandinavian Journal of Economics, Wiley Blackwell, vol. 93(3), pages 447-455.
    9. Zhu, Xiaodong, 1995. "Endogenous capital utilization, investor's effort, and optimal fiscal policy," Journal of Monetary Economics, Elsevier, vol. 36(3), pages 655-677, December.
    10. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-491, June.
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