No Regret Fiscal Reforms

Pierre-Edouard Collignon

No 2021-20, Working Papers from Center for Research in Economics and Statistics

Abstract: How should fiscal policy react to shocks ex-post while preserving incentives to work and save ex-ante? The standard solution involves a commitment to a contingent policy, whereby the initial government sets all the policies for all future states of the world. Contingent policies are unrealistic. As an alternative, I introduce ”No Regret Fiscal Reforms”: the government has the discretion to change its fiscal policy provided households do not regret their past decisions. Hence flexibility is provided and incentives to work and save are preserved. Such reforms can be achieved by changing taxes on both capital and labor such that wealth effects exactly compensate substitution effects. In a representative agent framework, I study how a benevolent government uses No Regret fiscal reforms and I make comparisons to the optimal contingent policy. Both approaches yield very similar policies and allocations but No Regret reforms entail a small welfare loss. Second, I consider robustness to Near-Rational Expectations i.e the government is uncertain of the households’ beliefs about the distribution of shocks and implements a policy robust to this uncertainty. No Regret fiscal reforms are fully robust to this departure from rational expectations. Finally, I characterize No Regret fiscal reforms with wealth and skill heterogeneity.

Keywords: Ramsey model; stochastic publics pending; fiscal rule; discretion (search for similar items in EconPapers)
JEL-codes: E61 E62 H21 H63 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2021-11-08
New Economics Papers: this item is included in nep-dge, nep-mac, nep-ore and nep-pub
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