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Secular Stagnation, Rational Bubbles, and Fiscal Policy

Listed author(s):
  • Coen N. Teulings

    (University of Cambridge, United Kingdom; University of Amsterdam, The Netherlands)

It is well known that rational bubbles can be sustained in balanced growth path of a deterministic economy when the return to capital r is equal to the growth rate g . When there is a lack of stores of value, bubbles can implement an efficient allocation. This paper considers a world where r fluctuates over time due to shocks to the marginal productivity of capital. Then, bubbles further efficiency, though they cannot implement first best. While bubbles can only be sustained when r = g in a deterministic economy, r > g "on average" in a stochastic economy. Fiscal policy improves welfare by adding an extra asset. Where only the elderly contribute to shifting resources between investment and consumption in a bubbly economy, fiscal policy allows part of that burden to be shifted to the young. Contrary to common wisdom, trade in bubbly assets implements intergenerational transfers, while fiscal policy implements intragenerational transfers. Hence, while bubbles and fiscal policy are perfect substitutes in the deterministic economy, fiscal policy dominates bubbles in a stochastic economy. For plausible parameter values, a higher degree of dynamic inefficiency should lead to a higher sovereign debt.

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Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 16-081/VI.

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Date of creation: 03 Oct 2016
Handle: RePEc:tin:wpaper:20160081
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