Optimal fiscal policy in the Uzawa-Lucas model with externalities

Summary. This paper devises a fiscal policy by means of which the first-best optimum equilibrium is attained as a market equilibrium in the Uzawa-Lucas model when average human capital has an external effect on productivity. The optimal policy requires the use of a subsidy to investment in human capital which can be financed by a tax on labor income. Lump-sum taxation is not required to balance the government budget either in the steady state or in the transitional phase. Physical capital income should not be taxed. Alternatively, the optimal growth path can be attained by means of a subsidy to human capital. Received: March 21, 2002; revised version: September 4, 2002 RID="*" ID="*" Financial support from the Spanish Ministry of Science and Technology through PNICDYIT grant SEC2002-03663 is gratefully acknowledged.     

The sustainability of Portuguese fiscal policy from a historical perspective

This paper analyses the sustainability of Portuguese public finances, making use of a long dataset with more than a full century of observations. The use of such a long dataset is appropriate because both the unit root and co-integration tests on which the sustainability testing procedure is based require a long period of data. We find considerable evidence in favor of sustainability for the 1903–2003 period which is not, however, maintained for the more recent 1975–2003 period, as it is characterized by the largest GDP deficit ratios of our sample. This latter period appears to signal a shift to an unsustainable path in Portuguese fiscal policy. Hence, our results suggest that fiscal consolidation efforts must, in fact, be continued in Portugal.Paper presented at the 2004 CESifo-LBI Conference on “Sustainability of Public Debt”, October 22–23 2004, Munich.     

Optimal simple rules for the conduct of monetary and fiscal policy

Stabilization policy involves joint monetary and fiscal rules. We develop a model enabling us to characterize systematic simple monetary and fiscal policy over the business cycle. We principally focus on the following question. What are the key properties of the joint simple rule governing the conduct of systematic stabilization policy? We find that conducting stabilization policy incorporates not only a set of monetary policy choices governed by the so-called ‘Taylor principle’ but also fiscal policy that gives considerable force to automatic stabilizers. Recent US and UK monetary and fiscal choices seem broadly consistent with this model. This result is found to be robust to a number of alternate modeling strategies.     

Optimal choice of monetary policy instruments under velocity and fiscal shocks

This paper, in the spirit of Poole [Poole, William, 1970. The Optimal Choice of Monetary Policy Instruments in a Simple Macro Model. Quarterly Journal of Economics, 84, 192–216.], studies how differently monetary and fiscal shocks influence the appropriate choice of the monetary policy regime. Velocity shocks are introduced by embedding a stochastic cash-in-advance constraint within the New Keynesian framework. In addition to optimal policy under discretion, three classic rules, interest rate targeting, monetary targeting, and the Taylor rule are ranked under both fiscal and velocity shocks. The non-stationarity of prices under the Taylor rule makes it inferior to the other rules under which prices are stationary. Monetary targeting, by stabilizing aggregate demand under fiscal shocks, outperforms interest rate targeting, while the latter provides a better insulation against velocity shocks. Monetary targeting (under fiscal shocks) and interest rate targeting (under velocity shocks) even outperform the optimal policy under discretion for sufficiently high intertemporal elasticities of consumption substitution.     

Identifying optimal contingent fiscal policies in a business cycle model

Optimal fiscal policy is indeterminate in a dynamic and stochastic environment. The complete characterization of the fiscal policy requires the use of identification constraints. In the literature either capital taxes or debt have been restricted to be not contingent on the state of nature. We propose a different type of identification constraints to have both policy variables state-contingent. Three alternative identification conditions are considered: (i) restrictions on the dynamic and stochastic behavior of the debt path; (ii) an exogenous debt path, and (iii) an exogenous belief function. The main result indicates that the optimal capital tax is zero and constant over the business cycle for any of the identification conditions used, suggesting that is optimal for the government to use debt return as a shock absorber, keeping capital taxes constant. The result is quite different from the previous literature, which obtains very volatile capital taxes. JEL Classification: E62, H21. We are grateful to Alfonso Novales, Víctor Ríos-Rull, Javier Vallés and two anonymous referees for helpful comments and suggestions. We acknowledge financial support from Spanish Ministerio de Ciencia y Tecnología (Ruiz and Pérez: BEC 2003-039; Manzano: BEC 2002-01995). Baltasar Manzano also acknowledges support from Xunta de Galicia (PGIDIT03PXIC30001PN, PGIDIT03CSO30001PR).     

Optimal fiscal policy in an endogenous growth model with public capital: a note

This note presents an investigation of the optimal tax rule in endogenous growth models with public capital. It is presumed that the government levies only an income tax in addition to financing public investment. Furthermore, a household’s saving is deducted from the income tax. We find the optimal tax rule whereby the social optimum is attainable. The manner by which a government imposes a tax on income and administers tax deductions is important for attaining a socially optimal situation.      

Optimal taxation, global externalities and labor mobility

This paper concerns transboundary environmental problems in the context of an optimal tax model. We assume that part of the labor force is mobile across countries, and that the set of tax instruments includes a nonlinear income tax and a commodity tax on the ‘dirty’ good that is causing damage to the environment. The purpose is to compare the (globally optimal) second best policy of a cooperative equilibrium with the policy implicit in a noncooperative equilibrium. We show that the commodity taxes differ between equilibria because of: (i) transboundary externalities not internalized by national governments, (ii) interaction effects between environmental and other policies, and (iii) labor mobility.     

Efficient taxation, wage bargaining and policy coordination

This paper is related to the literature on optimal nonlinear taxation under right-to-manage wage formation, and we assume that the fall-back profit facing firms during wage bargaining depends on the profit they can obtain if moving production abroad. The purpose is to study how policy coordination among countries can be used to increase the welfare level in comparison with an uncoordinated equilibrium. We consider coordinated policy reforms with respect to the marginal taxation of labor income, the unemployment benefit and the provision of a public good. The results show that policy coordination that leads to fewer hours of work per employee and/or a reduction of the unemployment benefit will increase welfare compared to the uncoordinated equilibrium.     

Government debt and optimal monetary and fiscal policy

How do different levels of government debt affect the optimal conduct of monetary and fiscal policies? And what do these optimal policies imply for the evolution of government debt over time? To provide an answer, this paper studies a standard monetary policy model with nominal rigidities and monopolistic competition and adds to it a fiscal authority that issues nominal non-state contingent debt, levies distortionary labor income taxes and determines the level of public goods provision. Higher government debt levels make it optimal to reduce public spending, so as to dampen the adverse incentive effects of distortionary taxes, but also strongly influence the optimal stabilization response following technology shocks. In particular, higher debt levels give rise to larger risks to the fiscal budget and to tax rates. This makes it optimal to reduce government debt over time. The optimal speed of debt reduction is missed when using first-order approximations to optimal policies, but is shown to be quantitatively significant in a second-order approximation, especially when technology movements are largely unpredictable in nature.     

Pollution,abatement and balanced growth

The analysis of endogenous growth models with pollution often concentrates on steady state trajectories, under the assumption that the steady state is in some sense stable. In the present note we provide examples showing that this issue should be dealt with carefully. We use the Rebelo Ak model augmented with a stock of pollutants causing a negative externality. It is found that optimal growth is not necessarily balanced (contrary to the outcome of the standard Rebelo model). Moreover, the existence of the externality may affect long run optimal growth rates.The author is grateful to an anonymous referee for comments. All remaining errors are the author's sole responsibility.     

How elections affect fiscal policy and growth: revisiting the mechanism

This paper reconsiders the popular result that the lower is the probability of reelection, the greater is the incentive of incumbent politicians to choose short-sighted, inefficient policies. The set-up is a general equilibrium model of economic growth, in which fiscal policy is endogenously chosen under electoral uncertainty. Political parties can value possible economic benefits differently depending on whether they are in or out of power, and—by contrast with the literature—the relevant preference coefficient is a choice variable rather than an exogenous taste parameter. The main result is that, when political parties choose both economic policy instruments and preference coefficients, the fundamental reason for short-sighted policy is the extra rents from being in power per se.     

Optimal fishery harvesting rules under uncertainty

This paper derives the optimal fishery harvest policy in a real-option model with a stochastic logistic growth process, harvest-sensitive output price, and both fixed and variable harvesting costs. The policy specifies the harvest trigger and harvest size, while outputs from the model include the value of the fishery and the risk of extinction. The optimal policy is illustrated with data from the Pacific Halibut Fishery. For this particular case, the optimal policy recommends harvesting when the fish stock rises to about three-quarters the environmental carrying capacity, and the amount harvested should be approximately a quarter of the prevailing stock. This harvesting policy maximizes the value of the fishery, and importantly, the resulting risk of extinction is negligible. We also carry out some sensitivity analysis to see how the optimal policy (and the resulting fishery value and risk of extinction) change when the input parameters are varied, particularly the ecological parameters intrinsic growth rate and volatility of the stock, and also the economic parameters that have been ignored in previous papers (price sensitivity and fixed cost). If the optimal policy is followed, the risk of extinction will be negligible, except for very low growth rate and high volatility.     

Ramsey fiscal policy and endogenous growth

This paper examines the effects of fiscal policies on capital accumulation and economic performance in a simple endogenous growth model with elastic labor supply by focusing on the implementability of a competitive equilibrium with productive public spending and distortionary taxation. Given a feasible exogenous fiscal policy, productive public spending can, at first, lead to positive short-run and long-run growth in the unique competitive equilibrium. However, although strictly positive growth is possible in the short run, a Ramsey policy with productive public spending does not implement positive capital accumulation in the long run. Also, the local indeterminacy of Ramsey allocations, in conjunction with the global multiplicity, arises as an implementable competitive equilibrium with Ramsey policies: namely, a continuum of transitional dynamics and multiple balanced growth paths. I am grateful to Kazuo Nishimura, Theodore Palivos, Sang Hee Won, John Conlon, Apostolis Philippopoulos, Arved Ashby, In Ho Lee, Katsuaki Terasawa, and an anonymous referee of this journal for valuable comments and suggestions. I also thank seminar participants at Ioannina University, Kyoto University, University of Mississippi, and Seoul National University. This paper is supported by 2006 Sabbatical Project, Kyung Hee University.     

Environmental policy and growth when inputs are differentiated in pollution intensity

Environmental policy affects the distribution of market shares if intermediate goods are differentiated in their pollution intensity. When innovations are environment-friendly, a tax on emissions skews demand towards new goods which are the most productive. In this case, the tax has to increase along a balanced growth path to keep the market shares of goods of different vintages constant. Comparing balanced growth paths, we find that tightening the policy stance spurs innovation, because it increases the market share of recent vintages, and promotes environment-friendly technological progress. As a result the cost of environmental policy in terms of slower growth is weaker.     

Channels of transmission of environmental policy to economic growth: A survey of the theory

Economists generally hold that environmental regulations impose constraints on the production possibilities set and are therefore potentially harmful to economic growth. In recent years, however, it has been recognized that environmental regulation can enhance the prospects for growth if improved environmental quality increases the productivity of inputs or the efficiency of the education system. It is also held that environmental regulation promotes pollution abatement activity and can lead to the exploitation of increasing returns to scale in abatement. Furthermore, expectations of a better environment may encourage households to save. Finally, it has been conjectured that environmental regulations can stimulate innovation because R&D is a relatively clean activity and because the market share of clean innovations increases. Future empirical research should shed light on the relative importance of these different channels of transmission of environmental policy to the growth rate of the economy.     

Utility and production externalities, equilibrium efficiency and leisure specification

This paper analyzes the implications that the specification of the leisure activity has on the equilibrium efficiency in a two-sector endogenous growth model with human capital accumulation. We consider external effects of consumption and leisure in utility, and sector-specific externalities associated to physical and human capital in production. The optimal tax policy to correct for the distortions caused by the externalities is characterized under all the typical leisure specifications considered in the literature: home production, quality time and raw time. We show that the optimal policy depends markedly on the leisure specification.     

Fiscal policy,government debt,and economic growth in the Kaleckian model of growth and distribution

This article presents the Kaleckian model of growth and distribution that sets a budget deficit ratio as an indicator of fiscal policy and examines the short- and long-run effects of an increase in budget deficits and a rise in income tax rates on the economy. The key short-run outcomes are as follows. First, expanded budget deficits have a positive effect on the rate of capacity utilization. Second, the tax rate for wage income does not affect the rate of capacity utilization, whereas the tax rate for capital income has a favorable impact on it. This result implies that raising the tax rate for capital income can be an important policy instrument for stimulating the economy. Third, we find that the economy exhibits a wage-led aggregate demand in the short run. The main long-run results are as follows. First, the effect of expanded budget deficits on the growth rate is ambiguous, since a higher debt burden negatively influences the rate of capacity utilization and hence economic growth, despite the increase in demand caused by government borrowing. A higher budget deficit ratio thus raises the growth rate only if a certain condition is satisfied. Second, the tax rate for capital income has a positive impact on the growth rate. Third, the economy shows a wage-led growth in the long run.     

Efficiency, depth and growth: Quantitative implications of finance and growth theory

We develop a parsimonious finance and endogenous growth model with microeconomic frictions in entrepreneurship and a role for credit constraints. We demonstrate that though an efficiency–growth relation will always exist, the efficiency–depth–growth relation may not. This has implications for the connection between the theory and empirics of finance and growth. We go on to ask whether the model can account for some historical trends in growth, financial depth and financial efficiency for the UK over the period 1850–1913. The best model of finance and growth is one that departs from the standard depth–growth link.     

Optimal fiscal policy in a world liquidity trap

We construct a model of the international transmission of ‘liquidity trap’ shocks, and examine the case for international coordination of fiscal policy to respond to the liquidity trap. Integrated financial markets tend to propagate liquidity traps. In a global environment, fiscal policy may be effective in raising GDP when the economy is stuck in a liquidity trap, but it does so in a ‘beggar thy neighbor’ fashion; when one economy is in a liquidity trap, the cross country spillover effect of fiscal policy is negative. We examine the welfare optimizing policy response to a liquidity trap when countries coordinate on fiscal policy. Fiscal policy may be an effective tool in responding to a liquidity trap, although it is never optimal to use fiscal expansion sufficiently to fully eliminate a downturn. Moreover, there is little case for coordinated global fiscal expansion. For the most part, the country worst hit by a liquidity trap shock should use its own policies to respond, without much help from foreign policies.