A neoclassical fiscal framework for a growing economy

Abstract

Neokeynesian models emphasize government policy to smooth out the short run business cycles; NEOCLASSICAL models point to the neutrality of anticipated counter cyclical policy, discarding feed-back rules from the short run state of the economy to the settings of monetary and fiscal policies. My purpose in these notes is to formulate an expanded version (with public investment and public debt) of Friedman's (1957) NEOCLASSICAL FISCAL FRAMERWORK, whose policy proposals, as pointed out by Lucas (1981), may have increasing acceptance and influence at the light of new theoretical developments. The neoclassical fiscal rules are derived from a dynamic optimization program concerned with "long run efficiency or prospects for growth of the economic system", as suggested by Friedman. Government expenditures, public capital formation, taxation and public debt emission are determined irrespectively of short run cyclical fluctuations. A neoclassical fiscal framework whereby the government levies taxes to finance consumption, issues debt for financing public capital formation, charges a rental price for public capital services according to its marginal productivity and uses the proceeds to pay interest on public debt along the optimal growth path is shown to be an optimal public policy.