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A Ramsey Theory of Financial Distortions

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  • Marco Bassetto
  • Wei Cui

Abstract

The return on government debt is lower than that of asset with similar payoffs. We study optimal debt management and taxation when the government cannot directly redistribute towards the agents in need of liquidity but otherwise has access to a complete set of linear tax instruments. Optimal government debt provision calls for gradually closing the wedge between the returns as much as possible, but tax policy may work as a countervailing force: as long as financial frictions bind, it can be optimal to tax capital even if this magnifies the discrepancy in returns.

Suggested Citation

  • Marco Bassetto & Wei Cui, . "A Ramsey Theory of Financial Distortions," Staff Report, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmsr:95726
    DOI: 10.21034/sr.643
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    More about this item

    Keywords

    Capital tax; Financing constraints; Asset liquidity; Optimal level of government debt; Low interest rates;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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