The Implications for Fiscal Policy

Abstract

Before we now finally come to solve the fiscal policy problem of the government in power in the first period, let us recapitulate what we have done in the previous chapter. First we have solved the individual consumers’ savings problem, given some fiscal policy announcement (τ, S). We then derived the optimal tax rate the parties will wish to set in the second period given the debt inherited from the first period. We have then rewritten the problem in terms relevant for the government’s policy decision. We argued that the government is interested in the overall consequences of its actions and not in what each single individual in the society does. Rewriting the model makes it also technically easier to handle and we can even eliminate the influence of the exogeneous beliefs when solving the elections’ problem. We then derived ρ as the variable determining the whole system and analyzed the election outcome as a function of ρ. We first restricted our economy to two types of distributions so that we could derive clear-cut results concerning the electoral outcome as a function of ρ. We then derived election outcome functions for both types of society. Finally, we introduced μ as an indicator for the economy’s political attitude.