Journal Article

Intertemporal Distortions in the Second Best

Stefania Albanesi and Roc Armenter

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 79, issue 4, pages 1271-1307
Published in print October 2012 | ISSN: 0034-6527
Published online February 2012 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1093/restud/rds014
Intertemporal Distortions in the Second Best

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  • Fiscal Policies and Behaviour of Economic Agents
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This paper studies the long-run properties of intertemporal distortions in a broad class of second-best economies. Our unified framework encompasses and extends many well-known models, such as variants of the Ramsey taxation model with aggregate or idiosyncratic risk, and economies with incentive compatibility constraints due to limited commitment, political economy, self-enforcement or private information, or combinations of these. We identify a sufficient condition that rules out permanent intertemporal distortions: if there exists an allocation that satisfies all constraints and eventually converges to the limiting first-best allocation, then intertemporal distortions are temporary in the second best. This result uncovers a common optimality principle linking the intertemporal allocation of resources with the ability to front-load distortions for this broad class of environments. A series of applications illustrates the significance of these findings.

Keywords: Intertemporal distortions; Second best; Ramsey policies; Limited commitment; Private information; Self-enforcement constraints; E6; H21; H3

Journal Article.  17069 words. 

Subjects: Fiscal Policies and Behaviour of Economic Agents ; Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook ; Taxation, Subsidies, and Revenue

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