39 Pages Posted: 3 Nov 2009 Last revised: 29 Aug 2013
Date Written: 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.
Keywords: Ramsey plan, misspecification, robustness, taxes, debt, martingale, expansion
JEL Classification: D80, E62, H21, H63
Suggested Citation: 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