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Working Paper
A Ramsey Theory of Financial Distortions
The interest rate on government debt is significantly lower than the rates of return on other assets. From the perspective of standard models of optimal taxation, this empirical fact is puzzling: typically, the government should finance expenditures either through contingent taxes, or by previously-issued state-contingent debt, or by labor taxes, with only minor effects arising from intertemporal distortions on interest rates. We study how this answer changes in an economy with financial frictions, where the government cannot directly redistribute towards the agents in need of liquidity, but ...
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 ...
Report
A Ramsey Theory of Financial Distortions
The return on government debt is lower than that of asset with similar payoffs. We study optimal debt management and taxation when the government cannot directly redistribute towards the agents in need of liquidity but otherwise has access to a complete set of linear tax instruments. Optimal government debt provision calls for gradually closing the wedge between the returns as much as possible, but tax policy may work as a countervailing force: as long as financial frictions bind, it can be optimal to tax capital even if this magnifies the discrepancy in returns.