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Policy and welfare effects of within-period commitment

Author

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  • Fernando M. Martin
Abstract
I study the implications of different institutional frameworks for the conduct of fiscal policy, under the assumption that the government cannot commit to future policy choices. The environments analyzed vary on whether the government is endowed with the ability to commit to beginning-of-period policy announcements or not. If it cannot, then there are two variants, depending on which actions private agents take before observing the government?s policy choice. How the three possible cases rank in terms of tax rates and welfare varies substantially with the economy?s fundamentals and whether depreciation is tax deductible or not. More generally, I find that regimes with higher tax rates do not necessarily imply lower welfare. I also find that making depreciation not tax-deductible typically involves a welfare loss. Within the context of the environments studied in this paper, I find that there are only small gains from modifying the way fiscal policy is conducted in modern developed economies. Furthermore, some reforms may lead to large welfare losses.

Suggested Citation

  • Fernando M. Martin, 2011. "Policy and welfare effects of within-period commitment," Working Papers 2011-031, Federal Reserve Bank of St. Louis.
    • Handle: RePEc:fip:fedlwp:2011-031
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    References listed on IDEAS

    as
    1. Martin, Fernando M., 2011. "On the joint determination of fiscal and monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(2), pages 132-145, March.
    2. Jang-Ting Guo & Kevin J. Lansing, 1997. "Tax structure and welfare in a model of optimal fiscal policy," Economic Review, Federal Reserve Bank of Cleveland, issue Q I, pages 11-23.
    3. Salvador Ortigueira, 2006. "Markov-Perfect Optimal Taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(1), pages 153-178, January.
    4. Christopher Phelan & Ennio Stacchetti, 2001. "Sequential Equilibria in a Ramsey Tax Model," Econometrica, Econometric Society, vol. 69(6), pages 1491-1518, November.
    5. Azzimonti, Marina & Sarte, Pierre-Daniel & Soares, Jorge, 2009. "Distortionary taxes and public investment when government promises are not enforceable," Journal of Economic Dynamics and Control, Elsevier, vol. 33(9), pages 1662-1681, September.
    6. Salvador Ortigueira & Joana Pereira, 2007. "Markov-Perfect Optimal Fiscal Policy: The Case of Unbalanced Budgets," Economics Working Papers ECO2007/41, European University Institute.
    7. Fernando Martin, 2009. "A Positive Theory of Government Debt," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(4), pages 608-631, October.
    8. Turnovsky, Stephen J. & Brock, William A., 1980. "Time consistency and optimal government policies in perfect foresight equilibrium," Journal of Public Economics, Elsevier, vol. 13(2), pages 183-212, April.
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    10. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711, April.
    11. Pecorino, Paul, 1993. "Tax structure and growth in a model with human capital," Journal of Public Economics, Elsevier, vol. 52(2), pages 251-271, September.
    12. Martin, Fernando M., 2010. "Markov-perfect capital and labor taxes," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 503-521, March.
    13. Daniel Cohen & Philippe Michel, 1988. "How Should Control Theory Be Used to Calculate a Time-Consistent Government Policy?," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 55(2), pages 263-274.
    14. David R. Stockman, 2001. "Balanced-Budget Rules: Welfare Loss and Optimal Policies," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(2), pages 438-459, July.
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    Cited by:

    1. Marina Azzimonti, 2018. "The Politics Of Fdi Expropriation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 59(2), pages 479-510, May.

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    Keywords

    Fiscal policy; Welfare; Equilibrium (Economics);
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