The Determination of Public Debt under both Aggregate and Idiosyncratic Uncertainty

YiLi Chien and Yi Wen

No 2019-038, Working Papers from Federal Reserve Bank of St. Louis

Abstract: We use an analytically tractable, heterogeneous-agent incomplete-markets model to show that the Ramsey planner's decision to finance stochastic public expenditures implies a departure from tax smoothing and an endogenous mean-reverting force to support positive debt growth despite the government's precautionary saving motives. Specifically, the government's attempt to balance the competing incentives between its own precautionary saving (tax smoothing) and households' precautionary saving (individual consumption smoothing)---even at the cost of extra tax distortion---implies an endogenous, soft lower bound on the stochastic unit-root dynamics of optimal taxes and public debt.

Keywords: Ramsey Problem; Tax Smoothing; Optimal Public Debt; Incomplete Markets (search for similar items in EconPapers)
JEL-codes: E13 E62 H21 H30 (search for similar items in EconPapers)
Pages: 53 pages
Date: 2019-12-05, Revised 2022-04-28
New Economics Papers: this item is included in nep-dge, nep-ias, nep-mac and nep-pbe
Note: Publisher DOI: https://doi.org/10.1016/j.jet.2022.105474
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Citations: View citations in EconPapers (6)

Published in Journal of Economic Theory

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Journal Article: The determination of public debt under both aggregate and idiosyncratic uncertainty (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedlwp:86669

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DOI: 10.20955/wp.2019.038

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