CFCM 15/01: This time is different: a problem with raising taxes

Abstract

This paper investigates the syndrome of  “this time is different” with respect to Reinhart and Rogoff’s (2011) interpretation of their extensive, historical data on financial default, and with regard to public debt in a closed-economy. Recurrent promises to credulous investors of an ex ante, policy-optimal return that always exceeds its actual value amounts to an extra policy instrument through raising the demand for public debt. In a version of the Diamond (1965) model, we find the policy-maker has a strong incentive to resort to this strategy, only if taxes cannot be set at a policy-optimal level, suggesting that inadequate fiscal infrastructure is at the root of the problem.

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Update March 2017:  
This paper has been accepted by the journal Economic Change and Restructuring under the revised title "Recurrent default on public debt or policy-optimal taxation".

Authors

Mark Roberts

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