Politically Optimal Fiscal Policy

28 Pages Posted: 12 Apr 2007

Date Written: March 2007


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.

JEL Classification: E62, H21, H39, H63

Suggested Citation

Kumhof, Michael and Yakadina, Irina V., Politically Optimal Fiscal Policy (March 2007). IMF Working Paper No. 07/68, Available at SSRN: https://ssrn.com/abstract=977806

Michael Kumhof (Contact Author)

CEPR ( email )

United Kingdom

Irina V. Yakadina

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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