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Quantifying the Distortionary Fiscal Cost of ‘The Bailout’

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  • Francisco Gomes

    ()
    (London Business School and CEPR)

  • Alexander Michaelides

    ()
    (London School of Economics, Central Bank of Cyprus, CEPR and FMG)

  • Valery Polkovnichenko

    ()
    (University of Texas at Dallas)

Abstract

We utilize an overlapping generations model with endogenous production and incomplete markets to quantify the distortionary costs associated with financing the increase in government expenditures directed to investments in the private sector in 2008 and 2009 (also known as ‘the bailout’), and its differential impact on different groups of the population (in the USA). In our baseline calibration, this distortion corresponds to a loss of approximately $300 billion dollars in total household consumption. For plausible alternative assumptions regarding both the expected and actual duration of this increase in expenditures, or the willingness of foreign institutions and/or investors in absorbing additional government debt, this number can increase to $800 billion. We find that the cost falls more dramatically on those households which are either older and/or wealthier. Retirees face approximately 50% of the cost, as younger agents still expect to be alive when the economy has returned to its steady-state. Across wealth groups, the top 25% of the wealth distribution bears almost two thirds of the cost.

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File URL: http://www.centralbank.gov.cy/media/pdf/NPWPE_No6_122009.pdf
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Bibliographic Info

Paper provided by Central Bank of Cyprus in its series Working Papers with number 2009-6.

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Length: 44 pages
Date of creation: Dec 2009
Date of revision:
Handle: RePEc:cyb:wpaper:2009-6

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Web page: http://www.centralbank.gov.cy/nqcontent.cfm?a_id=1
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Keywords: Fiscal Policy; tax distortions; bailout; incomplete markets;

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