Optimal Fiscal Policy Without Commitment: Beyond Lucas-Stokey

44 Pages Posted: 23 Apr 2018

See all articles by Davide Debortoli

Davide Debortoli

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

Ricardo Nunes

University of Surrey

Pierre Yared

Columbia Business School - Finance and Economics

Multiple version iconThere are 2 versions of this paper

Date Written: April 2018

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.

Suggested Citation

Debortoli, Davide and Nunes, Ricardo and Yared, Pierre, Optimal Fiscal Policy Without Commitment: Beyond Lucas-Stokey (April 2018). NBER Working Paper No. w24522. Available at SSRN: https://ssrn.com/abstract=3167037

Davide Debortoli (Contact Author)

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 Nunes

University of Surrey ( email )

Guildford
Guildford, Surrey GU2 5XH
United Kingdom

Pierre Yared

Columbia Business School - Finance and Economics ( email )

3022 Broadway
Uris Hall
New York, NY 10027
United States

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