Robust-Optimal Fiscal Policy
29 Pages Posted: 28 Jun 2007
Date Written: June 2005
This paper introduces a concern for model misspecification in a Lucas-Stokey optimal fiscal policy setting. The representative household in this economy is endowed with the knowledge of a reference model for the government spending process but acknowledges that this model is potentially misspecified. The paper shows how this concern for misspecification affects the competitive equilibrium pricing of state contingent bonds and how this in turn affects the calculation of present value budget constraints. The paper shows how the Ramsey problem and optimal solutions are affected by the size of potential misspecifications entertained. The implications for optimal maturity structure for non-contingent debt are analysed, paying particular attention to how the pricing of these assets is affected by robustness considerations. A linear quadratic specification serves to implement numerically the economy under study.
Keywords: Optimal Fiscal Policy, Optimal Maturity Structure, Model Misspecification, Robustness
JEL Classification: E43, E60, E62, H21, H30, H60, D80
Suggested Citation: Suggested Citation