Robust-Optimal Fiscal Policy

29 Pages Posted: 28 Jun 2007

See all articles by Vasco M. Carvalho

Vasco M. Carvalho

Universitat Pompeu Fabra/CREI; Centre for Economic Policy Research (CEPR); University of Cambridge

Date Written: June 2005

Abstract

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

Carvalho, Vasco M., Robust-Optimal Fiscal Policy (June 2005). Available at SSRN: https://ssrn.com/abstract=997142 or http://dx.doi.org/10.2139/ssrn.997142

Vasco M. Carvalho (Contact Author)

Universitat Pompeu Fabra/CREI ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

HOME PAGE: http://www.crei.cat/people/carvalho/welcome.html

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

University of Cambridge ( email )

Trinity Ln
Cambridge, CB2 1TN
United Kingdom

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