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Politically Optimal Fiscal Policy

Politically Optimal Fiscal Policy by Irina Yakadina
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Why do governments issue large amounts of debt? In what sense and for whom is such a policy optimal? We show that twisting the optimal taxation paradigm produces very reasonable predictions for debt and real interest rates. Adding an extra dimension of uncertainty about the political planning horizon gives rise to a positive and very plausible government debt-to-GDP ratio of about 55 percent in a model that otherwise predicts negative government debt. We quantify the impact of political uncertainty on steady state and business cycle dynamics. We illustrate how populist tax cuts can cause business cycle fluctuations.
International Monetary Fund; March 2007
26 pages; ISBN 9781452738017
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Title: Politically Optimal Fiscal Policy
Author: Irina Yakadina; Michael Kumhof