Optimal Fiscal Policy with Recursive Preferences

91 Pages Posted: 30 Aug 2013 Last revised: 16 Dec 2017

See all articles by Anastasios G. Karantounias

Anastasios G. Karantounias

Federal Reserve Banks - Federal Reserve Bank of Atlanta

Date Written: October 23, 2017

Abstract

I study the implications of recursive utility, a popular preference specification in macro-finance, for the design of optimal fiscal policy. Standard Ramsey tax-smoothing prescriptions are substantially altered. The planner over-insures by taxing less in bad times and more in good times, mitigating the effects of shocks. At the intertemporal margin, there is a novel incentive for introducing distortions that can lead to an ex-ante capital subsidy. Overall, optimal policy calls for a much stronger use of debt returns as a fiscal absorber, leading to the conclusion that actual fiscal policy is even worse than we thought.

Keywords: Ramsey plan, tax smoothing, Epstein-Zin, recursive utility, excess burden, labor tax, capital tax, martingale, fiscal insurance.

JEL Classification: D80, E62, H21, H63

Suggested Citation

Karantounias, Anastasios G., Optimal Fiscal Policy with Recursive Preferences (October 23, 2017). Available at SSRN: https://ssrn.com/abstract=2317578 or http://dx.doi.org/10.2139/ssrn.2317578

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

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