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Managing Expectations and Fiscal Policy

39 Pages Posted: 3 Nov 2009 Last revised: 29 Aug 2013

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)

Date Written: October 1, 2009

Abstract

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.

Keywords: Ramsey plan, misspecification, robustness, taxes, debt, martingale, expansion

JEL Classification: D80, E62, H21, H63

Suggested Citation

Karantounias, Anastasios G. and Hansen, Lars Peter and Sargent, Thomas J., Managing Expectations and Fiscal Policy (October 1, 2009). Available at SSRN: https://ssrn.com/abstract=1498706 or http://dx.doi.org/10.2139/ssrn.1498706

Anastasios G. Karantounias (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States

Lars Peter Hansen

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Chicago - Department of Economics ( email )

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Chicago, IL 60637
United States
773-702-8170 (Phone)
773-702-8490 (Fax)

Thomas J. Sargent

New York University (NYU) - Department of Economics, Leonard N. Stern School of Business ( email )

269 Mercer Street
New York, NY 10003
United States
212-998-3548 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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