Fiscal Policy in the Ramsey Model October 2007 () Fiscal policy - - PowerPoint PPT Presentation

Fiscal Policy in the Ramsey Model

October 2007

() Fiscal policy October 2007 1 / 8

A Balanced–Budget Increase in Government Consumption

Total tax revenue (lump-sum) equals to expenditure on “public consumption“: Tt = Gt. , ! these are measured per unit of e¤ective labour Aggregate resource constraint becomes ˙ kt = f (kt) ct Gt (n + g + δ)kt. , ! ( ˙ k = 0) locus: ct = f (kt) Gt (n + g + δ)kt. , ! intertemporal budget constraint:

Z ∞

ˆ Dtct = k0 +

Z ∞

ˆ Dt(wt Gt). No modi…cation to (˙ c = 0) locus — why?

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c=0 k=0 E0 E1 . . k c Figure: Permanent Increase in Government Spending

() Fiscal policy October 2007 3 / 8

Private consumption is completely crowded out , ! consumption falls due to a pure wealth e¤ect , ! output and r remains unchanged Could replace lump-sum tax here with a wage tax Tt = τtwt = G , ! implication is the same — why?

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Debt versus Tax Financing

Evolution of government debt: ˙ B = rtBt + GtAtLt TtAtLt , ! in intensive form ˙ bt = (rt n g)bt + Gt Tt. Sustainability of public debt lim

T !∞

ˆ DT bT = 0 Government’s intertemporal budget constraint:

Z ∞

ˆ Dt(Tt Gt) = b0.

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Household’s budget constraint can be expressed as

Z ∞

ˆ Dtct = k0 + b0 +

Z ∞

ˆ Dt(wt Tt) = k0 +

Z ∞

ˆ Dt(wt Gt) , ! Ricardian equivalence: provided the government satis…es its budget constraint, whether or not spending is …nanced by debt or non-distortionary taxation is irrelevant , ! inde…nite planning horizon and interest rate equivalence are crucial for this result

() Fiscal policy October 2007 6 / 8

Distortionary Taxation of Capital

Assume revenue is remitted back to households in lump–sum fashion ) no impact on resource constraint After tax interest rate: ˜ rt = (1 τ)f 0(kt) δ ) Euler equation: ˙ ct ct = (1 τ)f 0(kt) δ ρ θg θ (˙ c = 0) locus: f 0(kt) = ρ + δ + θg 1 τ

() Fiscal policy October 2007 7 / 8

E E

1

c k c=0 k=0 . .

Figure: A Tax on Capital Income

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