Our website will undergo scheduled maintenance on the morning of Thursday, August 11, 2022. During this time, connection to our website and some of its features may be unavailable. Thank you for your patience and we apologize for any inconvenience.

Working Paper

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.

Keywords: Ramsey plans; tax smoothing; Epstein-Zin; recursive utility; excess burden; labor tax; capital tax; martingale; fiscal insurance;

JEL Classification: D80; E62; H21; H63;

Access Documents

Authors

Bibliographic Information

Provider: Federal Reserve Bank of Atlanta

Part of Series: FRB Atlanta Working Paper

Publication Date: 2015-04-01

Number: 2013-07

Pages: 91 pages