NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Optimal Fiscal Policy without Commitment: Beyond Lucas-Stokey

Davide Debortoli, Ricardo Nunes, Pierre Yared

NBER Working Paper No. 24522
Issued in April 2018, Revised in February 2019
NBER Program(s):Economic Fluctuations and Growth, Public Economics, Political Economy

According to the Lucas-Stokey result, a government can structure its debt maturity to guarantee commitment to optimal fiscal policy by future governments. In this paper, we overturn this conclusion, showing that it does not generally hold in the same model and under the same definition of time-consistency as in Lucas-Stokey. Our argument rests on the existence of an overlooked commitment problem that cannot be remedied with debt maturity: a government in the future will not tax on the downward slopping side of the Laffer curve, even if it is ex-ante optimal to do so. In light of this finding, we propose a new framework to characterize time-consistent policy. We consider a Markov Perfect Competitive Equilibrium, where a government reoptimizes sequentially and may deviate from the optimal commitment policy. We find that, in a deterministic economy, any stationary distribution of debt maturity must be flat, with the government owing the same amount at all future dates.

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Document Object Identifier (DOI): 10.3386/w24522

 
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