Working Paper: NBER ID: w24522
Authors: Davide Debortoli; Ricardo Nunes; Pierre Yared
Abstract: According to the Lucas-Stokey result, a government can structure its debt maturity to guarantee commitment to optimal fiscal policy by future governments. In this paper, we overturn this conclusion, showing that it does not generally hold in the same model and under the same definition of time-consistency as in Lucas-Stokey. Our argument rests on the existence of an overlooked commitment problem that cannot be remedied with debt maturity: a government in the future will not tax on the downward slopping side of the Laffer curve, even if it is ex-ante optimal to do so. In light of this finding, we propose a new framework to characterize time-consistent policy. We consider a Markov Perfect Competitive Equilibrium, where a government reoptimizes sequentially and may deviate from the optimal commitment policy. We find that, in a deterministic economy, any stationary distribution of debt maturity must be flat, with the government owing the same amount at all future dates.
Keywords: Fiscal Policy; Debt Maturity; Time Consistency
JEL Codes: E62; H21; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| size of initial debt (H63) | future tax rates (H29) |
| initial debt influences optimal tax policy (H21) | future governments' tax rates (H29) |
| lack of commitment (J22) | fiscal policy structure (E62) |
| structure of debt maturity (G32) | fiscal policy decisions (E62) |
| stationary distribution of debt maturity (H63) | uniformity in debt obligations (H74) |