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POLICY AND WELFARE EFFECTS OF WITHIN-PERIOD COMMITMENT

Published online by Cambridge University Press:  13 March 2014

Fernando M. Martin
Fernando M. Martin*
Affiliation:
Federal Reserve Bank of St. Louis
*
Address correspondence to: Fernando M. Martin, Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, MO 63166, USA; e-mail: fernando.m.martin@stls.frb.org.
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Abstract

Consider the problem of a benevolent government that needs to finance the provision of a public good with distortionary taxes and cannot commit to policies beyond the current period. In such a case, public expenditure is inefficiently low. If the government further loses the ability to set tax rates before production in the period takes place, then it will not internalize how its policy choices distort current factor markets. Thus, to counterbalance the costs of future distortions, it increases public good provision. For a calibrated economy, removing within-period commitment implies a welfare gain worth half a percent of yearly consumption. A similar gain can be obtained if instead, capital depreciation is allowed to be fully deducted from taxable income.

Keywords

Fiscal PolicyTime ConsistencyLack of CommitmentMarkov-Perfect Equilibrium
Type
Articles
Information
Macroeconomic Dynamics , Volume 19 , Issue 7 , October 2015 , pp. 1401 - 1426
Copyright
Copyright © Cambridge University Press 2014 

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