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Debt Policy under military threat

This paper introduces military threat to a framework of optimal fiscal policy that considers the need of tax smoothing and debt management. Military threat implies higher government spending and taxes, accompanied by discrete jumps of defense spending to confront actual conquering attempts by rivals. After designing an optimization framework, I use evidence from Israel, a country characterized by a high historical debt that has been reduced for the sake of future generations. My framework allows for assessing the impact of military events on the desired debt path. By running a simulation with parameters from actual fiscal policy in Israel I find a delay on the debt reduction path of seven years, caused by military confrontations. This figure is slightly higher than the desired optimal delay obtained by calibrating a theoretical framework.