Dynamic Optimization

The attainment of optimal economic growth is also an important objective of government. The market economy does not necessarily achieve optimal growth. This is because private decisions on consumption, saving, and investment do not consider the interest of future generations appropriately. If the current generation only considers its own interest, optimal growth is not realized from the viewpoint of generational equity. Thus, it becomes the government’s responsibility to consider the interest of future generations. The dynamic optimization problem of fiscal policy encompasses fiscal deficits, the burden of debt, and the productivity of public investment.

Further, a high level of economic growth is not always desirable. We have to consider the effect on the environment, among others. Public finance investigates how we should grow the economy in a way that is consistent with environmental quality as well as the interest of future generations.

We also investigate the effect of fiscal policy on growth. Public investment enhances economic growth. However, if the government raises taxes to finance various kinds of public spending, it may depress capital accumulation and economic growth. Similarly, an increase in government deficits and public pensions would crowd out private capital accumulation, thereby harming economic growth. The dynamic effect of fiscal variables is an important topic of macroeconomic public finance. Thus, Chap. 5 investigates the effect of fiscal policy on economic growth. In addition, Chap. 7 examines the effect of public pensions on economic growth in an aging economy such as Japan’s.

The Failure of Government

Although these four functions are important, the government may not behave efficiently. Because the market sometimes fails, the government could fail too. Since public economic activities are complicated, even an idealistic government cannot attain the best solution. Moreover, because of bureaucratic problems and so on, the government does not necessarily maximize social welfare in a political economy. Thus, we cannot assume an idealistic government in reality. Chapter 12 examines the outcome of fiscal policy in a political economy. Chapter 13 investigates the role of local governments in causing the failure of government and the policy implications of intergovernmental finance to correct such failure.

 
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