Policy and Welfare Effects of Within-Period Commitment

FRB of St. Louis Working Paper No. 2011-031C

28 Pages Posted: 15 Apr 2012 Last revised: 10 Jul 2013

See all articles by Fernando M. Martin

Fernando M. Martin

Federal Reserve Banks - Federal Reserve Bank of St. Louis

Date Written: July 8, 2013

Abstract

Consider the problem of a benevolent government that needs to finance the provision of a public good with distortionary taxes and cannot commit to policies beyond the current period. In such a case, public expenditure is inefficiently low. If the government further loses the ability to set tax rates before production in the period takes place, then it will not internalize how its policy choices distort current factor markets. Thus, to counterbalance the costs of future distortions, it increases public good provision. For a calibrated economy, removing within-period commitment implies a welfare gain worth half-a-percent of yearly consumption. A similar gain can be obtained, if instead, capital depreciation were allowed to be fully deducted from taxable income.

Keywords: Fiscal policy, time-consistency, lack of commitment, Markov-perfect equilibrium

JEL Classification: E61, E62

Suggested Citation

Martin, Fernando M., Policy and Welfare Effects of Within-Period Commitment (July 8, 2013). FRB of St. Louis Working Paper No. 2011-031C, Available at SSRN: https://ssrn.com/abstract=2038882 or http://dx.doi.org/10.2139/ssrn.2038882

Fernando M. Martin (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

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