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Abstract/Syllabus:

Dynamic Fiscal Policy

Dirk Krueger1
January 28, 2005

Contents

Preface ix
I Introduction 1
1 Empirical Facts of Government Economic Activity 5
1.1 The Size of Government in the Economy . . . . . . . . . . . . . . 5
1.2 The Structure of Government Budgets . . . . . . . . . . . . . . . 12
1.3 Government De…cits and Government Debt . . . . . . . . . . . . 19
II Dynamic Consumption Choices 25
2 A Two Period Benchmark Model 27
2.1 The Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
2.2 Solution of the Model . . . . . . . . . . . . . . . . . . . . . . . . 29
2.3 Comparative Statics . . . . . . . . . . . . . . . . . . . . . . . . . 34
2.3.1 Income Changes . . . . . . . . . . . . . . . . . . . . . . . 34
2.3.2 Interest Rate Changes . . . . . . . . . . . . . . . . . . . . 35
2.4 Borrowing Constraints . . . . . . . . . . . . . . . . . . . . . . . . 39
3 The Life Cycle Model 43
3.1 Solution of the General Problem . . . . . . . . . . . . . . . . . . 45
3.2 Important Special Cases . . . . . . . . . . . . . . . . . . . . . . . 47
3.2.1 Equality of ¯ = 1
1+r . . . . . . . . . . . . . . . . . . . . . 47
3.2.2 Two Periods and log-Utility . . . . . . . . . . . . . . . . . 50
3.2.3 The Relation between ¯ and 1
1+r and Consumption Growth 51
3.3 Empirical Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . 53
3.4 Potential Explanations . . . . . . . . . . . . . . . . . . . . . . . . 54
III Positive Theory of Government Activity 59
4 Dynamic Theory of Taxation 61
4.1 The Government Budget Constraint . . . . . . . . . . . . . . . . 62
4.2 The Timing of Taxes: Ricardian Equivalence . . . . . . . . . . . 64
4.2.1 Historical Origin . . . . . . . . . . . . . . . . . . . . . . . 64
4.2.2 Derivation of Ricardian Equivalence . . . . . . . . . . . . 65
4.2.3 Discussion of the Crucial Assumptions . . . . . . . . . . . 68
4.3 Consumption, Labor and Capital Income Taxation . . . . . . . . 73
4.3.1 Income Taxation . . . . . . . . . . . . . . . . . . . . . . . 73
4.3.2 Theoretical Analysis of Consumption Taxes, Labor Income
Taxes and Capital Income Taxes . . . . . . . . . . . 80
5 Unfunded Social Security Systems 93
5.1 History of the German Social Security System . . . . . . . . . . . 93
5.2 Theoretical Analysis . . . . . . . . . . . . . . . . . . . . . . . . . 95
5.2.1 Pay-As-You-Go Social Security and Savings Rates . . . . 95
5.2.2 Welfare Consequences of Social Security . . . . . . . . . . 97
5.2.3 The Insurance Aspect of a Social Security System . . . . 98
6 Social Insurance 101
6.1 International Comparisons of Unemployment and Unemployment
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101
6.2 Social Insurance: Theory . . . . . . . . . . . . . . . . . . . . . . 104
6.2.1 A Simple Intertemporal Insurance Model . . . . . . . . . 104
6.2.2 Solution without Government Policy . . . . . . . . . . . . 104
6.2.3 Public Unemployment Insurance . . . . . . . . . . . . . . 108




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