Managing Pessimistic Expectations and Fiscal Policy

Theoretical Economics 8 (2013), 193-231

Federal Reserve Bank of Atlanta Working Paper No. 2009-29a

50 Pages Posted: 1 Apr 2016

See all articles by Anastasios G. Karantounias

Anastasios G. Karantounias

Federal Reserve Banks - Federal Reserve Bank of Atlanta

Date Written: March 1, 2012

Abstract

This paper studies the design of optimal fiscal policy when a government that fully trusts the probability model of government expenditures faces a fearful public that forms pessimistic expectations. We identify two forces that shape our results. On the one hand, the government has an incentive to concentrate tax distortions on events that it considers unlikely relative to the pessimistic public. On the other hand, the endogeneity of the public’s expectations gives rise to a novel motive for expectation management that aims towards the manipulation of equilibrium prices of government debt in a favorable way. These motives typically act in opposite directions and induce persistence to the optimal allocation and the tax rate.

Keywords: Fiscal policy, misspecification, robustness, taxes, debt, martingale

JEL Classification: D80, E62, H21, H63

Suggested Citation

Karantounias, Anastasios G., Managing Pessimistic Expectations and Fiscal Policy (March 1, 2012). Theoretical Economics 8 (2013), 193-231, Federal Reserve Bank of Atlanta Working Paper No. 2009-29a , Available at SSRN: https://ssrn.com/abstract=2481233

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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