Federal Reserve Bank of Atlanta
FRB Atlanta Working Paper
Optimal Fiscal Policy with Recursive Preferences
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.
Cite this item
Anastasios G. Karantounias, Optimal Fiscal Policy with Recursive Preferences, Federal Reserve Bank of Atlanta, FRB Atlanta Working Paper 2013-07, 01 Sep 2013, revised 01 Jan 2018.
- D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
- H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
Keywords: Ramsey plan; tax smoothing; Epstein-Zin; recursive utility; excess burden; labor tax; capital tax; martingale; fiscal insurance
This item with handle RePEc:fip:fedawp:2013-07
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