Optimal fiscal policy with low interest rates for government debt

Philipp Pfeiffer, Werner Roeger and Lukas Vogel

Journal of Economic Dynamics and Control, 2021, vol. 132, issue C

Abstract: This paper analyzes optimal fiscal policy when the rate at which governments can borrow changes persistently. To analyze trade-offs, we allow for fiscal distortions and productive government spending and characterize the optimal mix between spending and revenue measures in a low rate environment. We find that low interest rates on government bonds can be welfare-enhancing if used by the government for fiscal measures that reduce the level of distortion, notably the labor tax, permanently. In the case of a general "flight-to-quality”, where households ask for a premium for holding physical (private) capital, the optimal policy is to increase the public-to-private capital ratio for as long as the shock persists. The associated financing needs should be met by a small increase in government debt and a temporary capital tax.

Keywords: Optimal fiscal policy; Distortionary taxes; Government investment; Interest rate; Safe rate; Risky rate; Secular stagnation (search for similar items in EconPapers)
JEL-codes: E62 H3 H4 H6 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:132:y:2021:i:c:s0165188921001457

DOI: 10.1016/j.jedc.2021.104210

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