Time-Consistent Fiscal Policy in a Debt Crisis

39 Pages Posted: 22 Nov 2016

See all articles by Neele Lisabet Balke

Neele Lisabet Balke

University College London

Morten O. Ravn

University College London

Date Written: November 2016

Abstract

We analyze time-consistent fiscal policy in a sovereign debt model. We consider a production economy that incorporates feedback from policy to output through employment, features inequality though unemployment, and in which the government lacks a commitment technology. The government's optimal policies play off wedges due to the lack of lump-sum taxes and the distortions that taxes and transfers introduce on employment. Lack of commitment matters during a debt crises -- episodes where the price of debt reacts elastically to the issuance of new debt. In normal times, the government sets procyclical taxes, transfers and public goods provision but in crisis times it is optimal to implement austerity policies which minimize the distortions deriving from default premia. Could a third party provide a commitment technology, austerity is no longer optimal.

Keywords: austerity, debt crisis, inequality, Sovereign debt, Time-consistent fiscal policy

JEL Classification: E20, E62, F34, F41

Suggested Citation

Balke, Neele Lisabet and Ravn, Morten O., Time-Consistent Fiscal Policy in a Debt Crisis (November 2016). CEPR Discussion Paper No. DP11646, Available at SSRN: https://ssrn.com/abstract=2873543

Neele Lisabet Balke (Contact Author)

University College London ( email )

Gower Street
London, WC1E 6BT
United Kingdom

Morten O. Ravn

University College London ( email )

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