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  • M326m173p?file=thumbnail
    Creator: Chari, V. V. and Kehoe, Patrick J.
    Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department)
    Number: 399
    Abstract:

    In this paper we analyze the constraints imposed by dynamic consistency in a model of optimal taxation. We assume that only distorting taxes are available to finance government consumption. Optimal fiscal policy requires the use of debt to smooth distortions over time. Dynamic consistency requires that governments at each point in time not have an incentive to default on the inherited debt. We consider policy functions which map the history of the economy including the actions of past governments into current decisions. A sustainable plan is a sequence of history-contingent policies which are optimal at each date given that future policies will be selected according to the plan. We show that if agents discount the future sufficiently little and if government consumption fluctuates then optimal sustainable plans yield policies and allocations which are identical to those under full commitment. We contrast our notion of dynamic consistency with other definitions.

    Keyword: Economic policy, Debt, and Fiscal policy
    Subject (JEL): E62 - Fiscal Policy and E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination
  • Tt44pm866?file=thumbnail
    Creator: Chari, V. V. and Kehoe, Patrick J.
    Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department)
    Number: 354
    Abstract:

    In this paper we analyze the constraints imposed by dynamic consistency in a model of optimal taxation. We assume that only distorting taxes are available to finance government consumption. Optimal fiscal policy requires the use of debt to smooth distortions over time. Dynamic consistency requires that governments at each point in time not have an incentive to default on the inherited debt. We consider policy functions which map the history of the economy including the actions of past governments into current decisions. A sustainable plan is a sequence of history-contingent policies which are optimal at each date given that future policies will be selected according to the plan. We show that if agents discount the future sufficiently little and if government consumption fluctuates then optimal sustainable plans yield policies and allocations which are identical to those under full commitment. We contrast our notion of dynamic consistency with other definitions.

    Keyword: Fiscal policy, Economic policy, and Debt
    Subject (JEL): E62 - Fiscal Policy and E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination