Fiscal Policy and the Distribution of Consumption Risk

Abstract:     
Recent fiscal interventions have raised concerns about U.S. public debt, future fiscal pressure, and long-run economic growth. This paper studies fiscal policy design in an economy in which (i) the household is averse to both short- and long-run uncertainty, and (ii) growth is endogenously sustained through innovations whose market value depends on the tax system. By reallocating tax distortions through debt, fiscal policy alters both the composition of intertemporal consumption risk and the incentives to innovate. Tax policies aimed at short-run stabilization may substantially increase long-run tax and growth uncertainty and ultimately reduce both average growth and welfare.

Number of Pages in PDF File: 47

Keywords: Fiscal Policy, Endogenous Growth, Recursive Preferences, Welfare Costs

JEL Classification: E62, G1, H2, H3

working papers series