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Time consistent optimal fiscal policy over the business cycle


Feng, Zhigang (2012). Time consistent optimal fiscal policy over the business cycle. In: Midwest Macro Meeting, University of Notre Dame, South Bend, Chicago, US, 11 May 2012 - 13 May 2012, 1-39.

Abstract

This paper examines a dynamic stochastic economy with a benevolent government that cannot commit to future policies. Following Phelan and Stacchetti (2001), we consider sequential sustainable equilibria (SSE). We numerically solve for the set of equilibrium payoffs, and investigate whether the time consistency problem of capital income tax is quantitatively important. For a realistically calibrated economy, we find that the optimal sustainable capital income tax rate is pro-cyclical and close to zero on average, while the labor income tax is countercyclical.
Moreover, the welfare cost of no commitment is very small (0:22%) when compared with the Ramsey allocation. We also find that the best sustainable equilibrium outcome may achieve substantially higher social welfare than the
Markov-perfect equilibrium as considered by Klein, Krusell and Rios-Rull (2008).

This paper examines a dynamic stochastic economy with a benevolent government that cannot commit to future policies. Following Phelan and Stacchetti (2001), we consider sequential sustainable equilibria (SSE). We numerically solve for the set of equilibrium payoffs, and investigate whether the time consistency problem of capital income tax is quantitatively important. For a realistically calibrated economy, we find that the optimal sustainable capital income tax rate is pro-cyclical and close to zero on average, while the labor income tax is countercyclical.
Moreover, the welfare cost of no commitment is very small (0:22%) when compared with the Ramsey allocation. We also find that the best sustainable equilibrium outcome may achieve substantially higher social welfare than the
Markov-perfect equilibrium as considered by Klein, Krusell and Rios-Rull (2008).

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Additional indexing

Item Type:Conference or Workshop Item (Paper), not refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Event End Date:13 May 2012
Deposited On:20 Apr 2012 08:11
Last Modified:05 Apr 2016 15:47
Related URLs:http://www.nd.edu/~nmark/2012MMM/2012MMMhomepage01.html
Permanent URL: https://doi.org/10.5167/uzh-61821

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