Myopic governments and welfare-enhancing debt limits
AbstractThis paper studies welfare consequences of a soft borrowing constraint on sovereign debt which is modeled as a proportional fine per unit of debt exceeding some reference value. Debt is the result of myopic fiscal policy where the government is assumed to have a smaller discount factor than the private sector. Due to the absence of lump-sum taxation, debt reduces welfare. The paper shows that the imposition of a soft borrowing constraint, which resembles features of the Stability and Growth Pact and which is taken into account by the policy maker when setting its instruments, prevents excessive borrowing. The constraint can be implemented such as to (i) control the long run level of debt, (ii) prevent debt accumulation, and (iii) induce debt consolidation. In all three cases the constraint enhances welfare and in a welfare ranking these gains outweigh the short run welfare losses of increasing the costs of using debt to smooth taxes over the business cycle. JEL Classification: H3, H63, E6
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Bibliographic InfoPaper provided by European Central Bank in its series Working Paper Series with number 1308.
Date of creation: Mar 2011
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Find related papers by JEL classification:
- H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents
- H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
- E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-03-19 (All new papers)
- NEP-DGE-2011-03-19 (Dynamic General Equilibrium)
- NEP-MIC-2011-03-19 (Microeconomics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Jonsson, Magnus & Klein, Paul, 2003. "Tax distortions in Sweden and the United States," European Economic Review, Elsevier, vol. 47(4), pages 711-729, August.
- Luca Guerrieri & Matteo Iacoviello & Raoul Minetti, 2012.
"Banks, Sovereign Debt and the International Transmission of Business Cycles,"
in: NBER International Seminar on Macroeconomics 2012, pages 181-213
National Bureau of Economic Research, Inc.
- Luca Guerrieri & Matteo Iacoviello & Raoul Minetti, . "Banks, Sovereign Debt, and the International Transmission of Business Cycles," NBER International Seminar on Macroeconomics, University of Chicago Press, vol. 9(1), pages 181 - 213.
- Luca Guerrieri & Matteo Iacoviello & Raoul Minetti, 2012. "Banks, Sovereign Debt and the International Transmission of Business Cycles," NBER Working Papers 18303, National Bureau of Economic Research, Inc.
- Luca Guerrieri & Matteo Iacoviello & Raoul Minetti, 2012. "Banks, sovereign debt and the international transmission of business cycles," International Finance Discussion Papers 1067, Board of Governors of the Federal Reserve System (U.S.).
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