The Market Price of Fiscal Uncertainty
41 Pages Posted: 1 Nov 2011 Last revised: 10 Mar 2017
Date Written: October 31, 2011
Recent fiscal interventions have raised concerns about US public debt, future distortionary tax pressure and long-run growth potential. We explore the long-run implications of public financing policies aimed at short-run stabilization when: (i) agents are sensitive to model uncertainty as in Hansen and Sargent (2007), and (ii) growth is endogenous as in Romer (1990). We find that tax-smoothing policies promoting short-run stabilization generate a trade-off by simultaneously reducing the price of model uncertainty and significantly increasing the amount of long-run risk. Ultimately these tax policies depress innovation and long-run growth and may produce welfare losses.
Keywords: Robustness, Endogenous Growth, Asset Prices
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