Optimal Fiscal Policy without Commitment: Beyond Lucas-Stokey

43 Pages Posted: 2 May 2018 Last revised: 22 Feb 2019

See all articles by Davide Debortoli

Davide Debortoli

Universitat Pompeu Fabra - Department of Economics and Business; Barcelona Graduate School of Economics (Barcelona GSE)

Ricardo Cavaco Nunes

Federal Reserve Banks - Federal Reserve Bank of Boston

Pierre Yared

Columbia Business School - Finance and Economics

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Date Written: February 19, 2019

Abstract

According to the Lucas-Stokey result, a government can structure its debt maturity to guarantee commitment to optimal fiscal policy by future governments. In this paper, we overturn this conclusion, showing that it does not generally hold in the same model and under the same definition of time-consistency as in Lucas-Stokey. Our argument rests on the existence of an overlooked commitment problem that cannot be remedied with debt maturity: a government in the future will not tax on the downward slopping side of the Laffer curve, even if it is ex-ante optimal to do so. In light of this finding, we propose a new framework to characterize time-consistent policy. We consider a Markov Perfect Competitive Equilibrium, where a government reoptimizes sequentially and may deviate from the optimal commitment policy. We find that, in a deterministic economy, any stationary distribution of debt maturity must be flat, with the government owing the same amount at all future dates.

Keywords: public debt, optimal taxation, fiscal policy

JEL Classification: H63, H21, E62

Suggested Citation

Debortoli, Davide and Nunes, Ricardo Cavaco and Yared, Pierre, Optimal Fiscal Policy without Commitment: Beyond Lucas-Stokey (February 19, 2019). Columbia Business School Research Paper No. 18-36. Available at SSRN: https://ssrn.com/abstract=3156288 or http://dx.doi.org/10.2139/ssrn.3156288

Davide Debortoli

Universitat Pompeu Fabra - Department of Economics and Business ( email )

Barcelona
Spain

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Ricardo Cavaco Nunes

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

Pierre Yared (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
Uris Hall
New York, NY 10027
United States

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