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Optimal Fiscal Policy over the Business Cycle

Filippo Occhino ()

No 608, 2006 Meeting Papers from Society for Economic Dynamics

Abstract: How should taxes, government expenditures, the primary and fiscal surpluses and government liabilities be set over the business cycle? We assume that the government chooses expenditures and taxes to maximize the utility of a representative household, utility is increasing in government expenditures, only distortionary labor income taxes are available, and the cycle is driven by exogenous technology shocks. We first consider the commitment case, and characterize the Ramsey equilibrium. In the case that the utility function is constant elasticity of substitution between private and public consumption and separable between the composite consumption good and leisure, taxes, government expenditures and the primary surplus should all be constant positive fractions of production, and both government liabilities and the fiscal surplus should be positively correlated with production. Then, we relax the commitment assumption, and we show how to determine numerically whether the Ramsey equilibrium can be sustained by the threat to revert to a Markov perfect equilibrium. We find that, for realistic values of the preferences discount factor, the Ramsey equilibrium is sustainable.

Keywords: Fiscal policy; Commitment; Time-consistency; Ramsey equilibrium; Markov perfect equilibria; Sustainable equilibria. (search for similar items in EconPapers)
JEL-codes: E62 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-pbe and nep-upt
Date: 2006-12-03
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More papers in 2006 Meeting Papers from Society for Economic Dynamics Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA. Contact information at EDIRC.
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