Optimal Fiscal Policy in an Emerging Economy with Credit Constraints Theory and Application for Poland

Abstract

In this paper we develop an open-economy endogenous growth model to
examine the influence of fiscal policy on the economy in the long run. We
allow for public deficit and 5 types of taxes. One of the novel features is
separate treatment of interest rates on public and private debt, both of which are
linear functions of appropriate debt-to-GDP ratios. Two extreme situations are
analyzed: a model of “decentralized economy”, where economic agents do not
take into account any externalities, and a model of “benevolent social planner”.
We derive the rules of optimal fiscal policy that induce economic agents to
internalize all externalities. Theoretical results are illustrated with an empirical
analysis for Poland. The optimal values of several fiscal policy instruments for
Poland are calculated.