Managing Expectations and Fiscal Policy
Anastasios G. Karantounias
Federal Reserve Banks - Federal Reserve Bank of Atlanta
Lars Peter Hansen
University of Chicago - Department of Economics; National Bureau of Economic Research (NBER)
Thomas J. Sargent
New York University (NYU) - Department of Economics, Leonard N. Stern School of Business; National Bureau of Economic Research (NBER)
October 1, 2009
This paper studies an optimal fiscal policy problem of Lucas and Stokey (1983) but in a situation in which the representative agent's distrust of the probability model for government expenditures puts model uncertainty premia into history-contingent prices. This situation gives rise to a motive for expectation management that is absent within rational expectations and a novel incentive for the planner to smooth the shadow value of the agent's subjective beliefs to manipulate the equilibrium price of government debt. Unlike the Lucas and Stokey (1983) model, the optimal allocation, tax rate, and debt become history dependent despite complete markets and Markov government expenditures.
Number of Pages in PDF File: 39
Keywords: Ramsey plan, misspecification, robustness, taxes, debt, martingale, expansion
JEL Classification: D80, E62, H21, H63
Date posted: November 3, 2009 ; Last revised: August 29, 2013
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