3. Budget Deficits & Fiscal Policy: Optimal Fiscal Policy Flashcards
What is the framework considered in the Ramsey problem?
3 agents assumptions and 1 other
- Deterministic framework (nothing stochastic)
- Representative household which lives forever, enjoys consumption and leisure and rents labour and savings to the market
- Firms rent labour and capital from households and maximise profits
- Government spends on public goods (Gt) using labour and capital income taxes
What would be the best instrument for the government to pay for its expenditure on public goods?
Why?
Problem?
Lump sum (per-head) taxes
Efficient because there are no distortions at the margin
They are not implementable
Give a formula for the households utility in Ramseys framework (explain parameters and marginal utility of consumption and leisure)
U= ∑(t=0)^∞ β^t u(ct,lt)
where β>1, u’c>0, u’l>0
What is the formula for the household BC in Ramseys framework?
Explain
ct+k(t+1)+qtB(t+1)=(1-τt^l )wtlt+[1+(1-τt^k )(rt-δ)]kt+ Bt
The sum of consumn, savings and amount spent on gov bonds = taxed income, return on savings and repayments on bonds bought last period
What does the household choose in order to maximise utility given its BC?
What is this problem?
Consumption, leisure, savings and bonds bought this period B(t+1)
The standard problem of the representative household in the standard neoclassical model
What are the two ways that the household can save in the standard neoclassical growth model?
- Buy government bonds B(t+1)
- Put money in the bank (k)
What is the meaning of no arbitrage?
Where two actions that allow the household to do the same thing cost the same
In the context of the standard neoclassical model, what two things should be equal in cost?
Give the equation
The interest rate on savings put in the bank
should =
the interest on the bond price
1/qt = [1+(1-τt^k )(rt-δ)]
Give the firms aggregate production function for Ramseys framework
Yt = F(kt, lt)
where
Fk, Fl >0
Fkk, Fll
What are the firms profits in Ramseys framework?
Hence what is the maximisation problem
The firms output - the cost of capital - workers wages
max(kt,lt) F(kt,lt )-rt kt-wtlt
What are the FOC solutions for kt and lt from the firms maximisation problem?
Interpret these
F’k(kt,lt) = rt
F’l(kt,lt) = wt
Marg prod of capital in the economy = the return to capital
Marg prob of labour in the economy = wage rate
What are the 3 sources of government funds in this model?
- Labour income taxes
- Tax on savings (k)
- Receipts from sale of bonds
What is the equation for the governments BC in this model?
plus give the formula for total taxes Tt
Gt + Bt = τkt(1-δ)kt + τltwtl +qtB(t+1)
where Tt = τkt(1-δ)kt + τltwtl
What 3 agents must be considered in Ramseys model?
Households, firms, the government
Where does a normal competitive equilibrium occur in this model?
When the household maximises utility, firms maximise profits (both subject to their respective constraints) and the governments BC is satisfied
