Dynamic fiscal policy with regime-duration uncertainty: The tax-cut case

This essay incorporates the uncertainty agents face regarding the duration of the governmental deficit policies into the life-cycle model developed by Auerbach and Kotlikoff(1987). I assume that agents have a probability meas ure over the possible durations of current deficit policies. They make thei r savings decisions based upon these expectations, which are updated only a fter observing the government's action each period. In this setup the trans ition period is more interesting to policy evaluation as compared to the pe rfect foresight version of the model. Results suggest that individual expec tations and the actual fiscal policy implemented interact to determine the effect deficit policies have on capital formation.