A Ramsey Theory of Financial Distortions by Wei Cui

Join us for this weeks Macroeconomics Research Seminar, Autumn Term 2021.

Dr Wei Cui from the Department of Economics, at University of College London will present their research on A Ramsey Theory of Financial Distortions.

Abstract

The interest rate on government debt is significantly lower than the rates of return on similar assets. To shed light on this disparity, we study optimal taxation and debt management with financial frictions. The government cannot directly redistribute towards the agents in need of liquidity but otherwise has access to a complete set of linear tax instruments. Provided that doing so is feasible, optimal policy calls for the government to increase its debt up to the point at which it provides sufficient liquidity to avoid financial constraints, no matter how high the resulting labor-income taxes in the limit will be. In this case, capital-income taxes are zero in the long run, so returns on government debt and capital are equalized. However, if the fiscal space is insufficient, it can be optimal to increase the wedge between the rates of return on government debt and on capital by taxing capital. This is because there is a trade-off between the desire to mitigate financial frictions, which would call for subsidies, and the incentive to tax the quasi-rents accruing to producers of capital. For the same reason, it can be optimal to distort downward the interest rate on government debt in periods of high government spending.

This seminar will be held on campus in LTB 01. This event is open to all levels of study and is also open to the public, but will also be held on Zoom.

To register your place, please contact the seminar organisers.

This event is part of the Macroeconomics Research Seminar Series.