 Optimal fiscal policy with robust controlJournal of Economic Dynamics and Control, 2012, vol. 36, issue 3, 349-368 Abstract: This paper analyzes how consumer uncertainty affects optimal fiscal policy in the Lucas and Stokey (1983) framework. The consumers, lacking confidence in their knowledge of the stochastic environment, endogenously tilt their subjective probability model away from an approximating probability model. The government, though, is confident that the approximating probability model characterizes the stochastic environment. This confidence dichotomy reveals a range of possible objective functions for an altruistic government. I assume that the government maximizes the consumers' expected utility under the consumers' own subjective probability model. It is found that this government relies less heavily on labor taxes to absorb the fiscal shock than would be optimal if consumers were fully confident in their probability model. This policy helps mitigate the direct welfare cost associated with consumer uncertainty. I compare this policy to the one implemented by a government that maximizes the consumers' expected utility under the approximating probability model. Keywords: Robust control; Uncertainty; Taxes; Debt (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:36:y:2012:i:3:p:349-368 DOI: 10.1016/j.jedc.2011.08.013 Access Statistics for this article Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok More articles in Journal of Economic Dynamics and Control from Elsevier |
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