Politically Optimal Fiscal Policy

Author/Editor:

Irina Yakadina ; Michael Kumhof

Publication Date:

March 1, 2007

Electronic Access:

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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.

Series:

Working Paper No. 2007/068

Subject:

Expenditure Fiscal policy Labor taxes Public debt Real interest rates

English

Publication Date:

March 1, 2007

ISBN/ISSN:

9781451866322/1018-5941

Stock No:

WPIEA2007068

Pages:

26

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