Managing expectations and fiscal policy

Lars Hansen, Anastasios Karantounias and Thomas Sargent

No 2009-29, FRB Atlanta Working Paper from Federal Reserve Bank of Atlanta

Abstract: This paper studies an optimal fiscal policy problem of Lucas and Stokey (1983) but in a situation in which the representative agent's distrust of the probability model for government expenditures puts model uncertainty premia into history-contingent prices. This situation gives rise to a motive for expectation management that is absent within rational expectations and a novel incentive for the planner to smooth the shadow value of the agent's subjective beliefs to manipulate the equilibrium price of government debt. Unlike the Lucas and Stokey (1983) model, the optimal allocation, tax rate, and debt become history dependent despite complete markets and Markov government expenditures.

Date: 2009
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-pub
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Citations: View citations in EconPapers (19)

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