Optimal Fiscal Policy under Multiple Equilibria

Posted: 16 Feb 2013

See all articles by Huberto M. Ennis

Huberto M. Ennis

Federal Reserve Banks - Federal Reserve Bank of Richmond

Todd Keister

Rutgers, The State University of New Jersey - Department of Economics

Date Written: November 10, 2005

Abstract

We study optimal fiscal policy in an economy where (i) search frictions create a coordination problem and generate multiple, Pareto-ranked equilibria and (ii) the government finances the provision of a public good by taxing market activity. The government must choose the tax rate before it knows which equilibrium will obtain, and therefore an important part of the problem is determining how the policy will affect the equilibrium selection process. We show that when the equilibrium selection rule is based on the concept of risk dominance, higher tax rates make coordination on the Pareto-superior outcome less likely. As a result, taking equilibrium-selection effects into account leads to a lower optimal tax rate.

Keywords: coordination problems, equilibrium selection, search and matching, taxation

JEL Classification: E61, E62, H21, H41

Suggested Citation

Ennis, Huberto M. and Keister, Todd, Optimal Fiscal Policy under Multiple Equilibria (November 10, 2005). Journal of Monetary Economics, Vol. 53, No. 2, 2005. Available at SSRN: https://ssrn.com/abstract=2218539

Huberto M. Ennis

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

P.O. Box 27622
Richmond, VA 23261
United States

Todd Keister (Contact Author)

Rutgers, The State University of New Jersey - Department of Economics ( email )

75 Hamilton Street
New Brunswick, NJ 08901
United States

HOME PAGE: http://econweb.rutgers.edu/tkeister

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