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Fiscal Policy and the Balance Sheet of the Private Sector

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  • Gersbach, Hans
  • Rochet, Jean Charles
  • von Thadden, Ernst-Ludwig

Abstract

This paper characterizes optimal fiscal policy in a growth model with incomplete markets, heterogeneous agents (households and entrepreneurs), and idiosyncratic productivity risk. Entrepreneurs run risky production, which they cannot finance optimally because of an agency problem. In the second-best optimum, they issue continuously traded bonds. Households invest in private and public debt. The government has to finance an exogenous expenditure flow and maximizes a weighted sum of the welfare of entrepreneurs and households. We show that any constrained Pareto optimal allocation can be decentralized as a competitive equilibrium by issuing an appropriate amount of public debt, combined with suitable wealth taxation. Positive public expenditure shocks leave the optimal debt-to-GDP ratio unaffected and increase tax rates. Such shocks also determine whether r g in equilibrium, with different dynamics and fiscal sustainability in the two regimes.

Suggested Citation

  • Gersbach, Hans & Rochet, Jean Charles & von Thadden, Ernst-Ludwig, 2022. "Fiscal Policy and the Balance Sheet of the Private Sector," CEPR Discussion Papers 17529, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:17529
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    More about this item

    Keywords

    Incomplete financial markets; Heterogeneous agents; Debt; Taxes; Interest; Growth; Ponzi games;
    All these keywords.

    JEL classification:

    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D63 - Microeconomics - - Welfare Economics - - - Equity, Justice, Inequality, and Other Normative Criteria and Measurement
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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