FISCAL POLICY WITH LIMITED-TIME COMMITMENT

We propose a theory of optimal fiscal policy with 'Limited-Time Commitment'. In our framework, successive governments have commitment only over finite, overlapping horizons. We first show that key results in the 'Full Commitment' literature can often be sustained with a single period of commitment. We then solve a calibrated model in which 'Limited-Time Commitment' fails to implement the 'Full Commitment' policy, and find that one year (three years) of commitment recovers one-third (two-thirds) of the welfare losses relative to 'No Commitment'. Finally, we investigate the trade-off between commitment and flexibility in response to shocks.