The market price of fiscal uncertainty

Recent fiscal interventions have raised concerns about US public debt, future distortionary tax pressure, and long-run growth potential. We explore the long-run implications of public financing policies aimed at short-run stabilization when: (i) agents are sensitive to model uncertainty, as in Hansen and Sargent (2007), and (ii) growth is endogenous, as in Romer (1990). We find that countercyclical deficit policies promoting short-run stabilization reduce the price of model uncertainty at the cost of significantly increasing the amount of long-run risk. Ultimately these tax policies depress innovation and long-run growth and may produce welfare losses. ► In an endogenous growth model, growth depends on innovation's value. ► With robustness preferences, innovation's value depends on both risk and uncertainty. ► Fiscal policies promoting short-run stabilization decrease uncertainty. ► Fiscal policies promoting short-run stabilization increase long-run risk. ► Ultimately, short-run oriented fiscal policies depress long-run growth.