Dynamic Tax Smoothing with Financial Instruments

This paper discusses dynamic tax smoothing with financial instruments within a two-period deterministic framework where the interest rate is endogenously determined and affected by fiscal policy. The analysis focusses on the timing of taxes and how the interest rate affects the costs for tax smoothing through public debt. It shows that elasticity of the interest rate with respect to the supply of government-issued bonds is crucial when characterizing the optimal path of taxes.