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Reply to the First Referee



Thank you very much for the time, attention and care you devoted to examine my paper. I certainly shall correct the mistakes you mentioned in your note on Minor Points. Thank you for pointing this out. Regarding your main concern, I give my response to your points below. I print the passages of your report I comment on in bold and give my notes on these as normal text. In Schlichts words "the present value of the households lifetime income has increased by switching from a pay-as-you-go regime to a debt regime... As the value of their lifetime income stream has increased, they could have afforded higher expenditure." The problem with this statement is that the disposable income only increases because households are saving (buying government bonds). Yes. They do so because they are assumed to hold Barro expectations (that “rearrangements of the timing of taxes – as implied by budget deficits – have no first-order effect on the economy, ” [Barro, 1989, 51]). They therefore think that they have to buy bonds in order to use them for paying future taxes that they (wrongly) think are inevitable because the debt must be repaid. The debt trajectory – households asset trajectory – is endogenous to the household maximization problem. I agree, but Barro expectations rule that out. They imply no behavioral change if the government runs into debt when lowering taxes while keeping expenditure unchanged. The reason is that it is asserted that the government’s budget constraint would be violated without tax increases. My example shows that this is not the case. Thus, the constraint is not (1 + i) −t ct ≤ ∑ (1 + i) −t (Yt − Tt + i Dt) but (1 + i) −t ct ≤ ∑ (1 + i) −t (Yt − Tt) (1) Here I disagree. The households can spent their interest income if they wish. But let us assume that this is the correct budget constraint. Consider my case that the households are not satiated and exhaust their budget, and take your ct as my privat

Year: 2013
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