Optimal fiscal policy in business cycle economies with incomplete markets

Abstract

Individuals are constantly subject to income shocks that creates uncertainty and can turn the consumption dynamics volatile. In an economy with incomplete markets, this leads to precautionary savings, which increases the aggregate capital cumulation and reduces the interest rate, turning the self-insurance more difficult and costly. The government can counteract such effect through fiscal policy, for instance increasing the taxation progressivity or the level of debt. However, the insurance provision (and the redistribution) by the government usually comes with efficiency loss. The objective of this research project is to analyze what is the optimal fiscal policy design accounting for such trade-off between insurance provision and efficiency in economies with business cycle and incomplete markets. (AU)