Optimal fiscal policy in a business cycle model with public capital

In this paper a real business cycle model with optimal tax rates, government borrowing, and productive public capital is analysed. A specification that allows for multiple stochastic shocks (to technology and preferences) can reproduce some key features describing the cyclical behaviour of postwar U.S. fiscal policy. The optimally chosen policy variables fluctuate substantially over the business cycle, but they do not operate like automatic stabilizers.