Optimal Fiscal Policy with Recursive Preferences
Abstract: I study the implications of recursive utility, a popular preference specification in macrofinance, for the design of optimal fiscal policy. Standard Ramsey tax-smoothing prescriptions are substantially altered. The planner overinsures by taxing less in bad times and more in good times, mitigating the effects of shocks. At the intertemporal margin, there is a novel incentive for introducing distortions that can lead to an ex-ante capital subsidy. Overall, optimal policy calls for a much stronger use of debt returns as a fiscal absorber, leading to the conclusion that actual fiscal policy is even worse than we thought.
File format is application/pdf
Description: Full text
Provider: Federal Reserve Bank of Atlanta
Part of Series: FRB Atlanta Working Paper
Publication Date: 2015-04-01
Pages: 91 pages