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Fiscal Policy with Limited-Time Commitment

Author

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  • Alex Clymo

    (University of Amsterdam, the Netherlands)

  • Andrea Lanteri

    (Duke University, United States)

Abstract

We consider models where the Ramsey-optimal fiscal policy under Full Commitment (FC) is time-inconsistent and define a new notion of optimal policy, Limited-Time Commitment (LTC). Successive one-period lived governments can commit to future plans over a finite horizon. We provide a sufficient condition on the mapping from finite policy sequences to allocations, such that LTC and FC lead to the same outcomes. We then show that this condition is verified in several existing models, allowing FC Ramsey plans to be supported with a finite commitment horizon (often a single period). We relate the required degree of commitment to the economic environment: in economies without capital, the minimum degree of commitment required is given by the government debt maturity; in economies with capital and government balanced-budget constraints, the required commitment is given by the horizon over which the budget has to be balanced. Finally, we solve numerically for the LTC equilibrium of an economy where the equivalence result fails and show that a single year of commitment to capital taxes provides substantial welfare gains relative to the No-Commitment time-consistent policy.

Suggested Citation

  • Alex Clymo & Andrea Lanteri, 2016. "Fiscal Policy with Limited-Time Commitment," Tinbergen Institute Discussion Papers 16-056/VI, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20160056
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    References listed on IDEAS

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    Cited by:

    1. Hauk, Esther & Lanteri, Andrea & Marcet, Albert, 2021. "Optimal policy with general signal extraction," Journal of Monetary Economics, Elsevier, vol. 118(C), pages 54-86.
    2. de Groot, Oliver & Mazelis, Falk & Motto, Roberto & Ristiniemi, Annukka, 2021. "A toolkit for computing Constrained Optimal Policy Projections (COPPs)," Working Paper Series 2555, European Central Bank.
    3. Alessandro Villa, 2022. "Credit Misallocation and Macro Dynamics with Oligopolistic Financial Intermediaries," Working Paper Series WP 2022-41, Federal Reserve Bank of Chicago.
    4. Euiyoung Jung & Chul-In Lee, 2024. "Optimal fiscal policy under finite planning horizons," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 31(6), pages 1550-1583, December.

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    More about this item

    Keywords

    Optimal fiscal policy; time-inconsistency; limited commitment;
    All these keywords.

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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