Politically Optimal Fiscal Policy

March 1, 2007

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Format: Chicago

Irina Yakadina, and Michael Kumhof. Politically Optimal Fiscal Policy, (USA: International Monetary Fund, 2007) accessed July 15, 2025

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Why do governments issue large amounts of debt? In what sense and for whom is such a policy optimal? We show that twisting the optimal taxation paradigm produces very reasonable predictions for debt and real interest rates. Adding an extra dimension of uncertainty about the political planning horizon gives rise to a positive and very plausible government debt-to-GDP ratio of about 55 percent in a model that otherwise predicts negative government debt. We quantify the impact of political uncertainty on steady state and business cycle dynamics. We illustrate how populist tax cuts can cause business cycle fluctuations.

Subject: Expenditure, Fiscal policy, Labor taxes, Public debt, Real interest rates

Keywords: Objective function, Real interest rate, WP

Publication Details

Pages:

26
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2007/068
Stock No:

WPIEA2007068
ISBN:

9781451866322
ISSN:

1018-5941

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