Review of Economic Dynamics 10 (2007) 31–54
Time-consistent ﬁscal policy and
International Research Department, Federal Reserve Bank of New York, 33 Liberty Street, New York, NY 10045
Received 17 February 2006; revised 7 August 2006
Available online 12 September 2006
This paper characterizes the time-consistency properties of the set of Pareto efﬁcient (or second best)
ﬁscal policies, in a two-class, stochastic economy similar to that in [Judd, K.L., 1985, Redistributive taxation
in a simple perfect foresight model, Journal of Public Economics 28, 59–83]. The key ﬁnding is that the
continuation of any Pareto efﬁcient policy is always Pareto efﬁcient. Hence, to require any policy revision
to be approved by unanimity safeguards the time consistency of efﬁcient ﬁscal policy. I also show that any
Pareto efﬁcient policy from a timeless perspective can be rendered time consistent by a policymaker whose
objective function is given by a utilitarian social welfare function with precise welfare weights. These results
link the policymaker’s equity considerations with the credibility of efﬁcient ﬁscal policy.
2006 Elsevier Inc. All rights reserved.
JEL classiﬁcation: E61; E62
Keywords: Fiscal policy; Time-consistency; Equity considerations
In the representative agent model, the optimal ﬁscal policy is usually not time-consistent.
Hence its implementation in a rational expectations equilibrium requires a commitment technol-
ogy, as pointed out in Kydland and Prescott (1977) and Fischer (1980). However, ﬁscal policy is
rarely coded in constitutions—an obvious commitment device. There is a large literature explor-
ing alternative mechanisms that render the optimal ﬁscal policy time-consistent. In the absence of
The views expressed here are those of the author and do not necessarily reﬂect the position of the Federal Reserve
Bank of New York or the Federal Reserve System.
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1094-2025/$ – see front matter © 2006 Elsevier Inc. All rights reserved.