NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Uncertainty and the Design of Long-Run Fiscal Policy

Alan J. Auerbach, Kevin A. Hassett

NBER Working Paper No. 7036
Issued in March 1999
NBER Program(s):   PE   EFG

This paper explores optimal fiscal policy in an overlapping-generations general-equilibrium model under uncertainty and the impact on optimal policy of the introduction of a type of policy stickiness intended to account for the stylized fact that major reforms happen infrequently. In general, our analysis suggests not only that action should not be delayed, but further that action should actually be accelerated. The added realism of restrictions on the frequency of policy changes alters this result in two ways. The prospect of being unable to set policy in the future occasions even more precautionary saving today, if the government acts. However, the government may also choose not to set policy, and its inaction range is very asymmetric. Because the impact of its policies on the current elderly cannot be reversed in the future, the government is much more likely to choose inaction when fiscal tightening is called for. Thus, the optimal policy response over time might best be characterized by great caution in general, but punctuated by occasional periods of apparent irresponsibility.

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Document Object Identifier (DOI): 10.3386/w7036

Published:

  • Auerbach, A. J. and K. A. Hassett. "Fiscal Policy And Uncertainty," International Finance, 2002, v5(2,Summer), 229-249.
  • Auerbach, A. and R. Lee (eds.)Demographic Change and Fiscal Policy. Cambridge: Cambridge University Press, 2008.

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