Optimal fiscal policy with robust control (Q433644)

The paper analyses the impact of consumer uncertainty on optimal fiscal policy in the Lucas and Stokey (1983) framework. It is found that if the government is confident that the approximating probability model characterizes the stochastic environment that this government relies less heavily on labor taxes to absorb the fiscal shock than would be optimal if consumers were fully confident in their probability model. This policy helps mitigate the direct welfare cost associated with consumer uncertainty.