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Game Over: Simulating Unsustainable Fiscal Policy

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  • Richard W. Evans
  • Laurence J. Kotlikoff
  • Kerk L. Phillips

Abstract

Fiscal sustainability is one of the most pressing policy issues of our time. Yet it remains difficult to quantify. Official debt is plagued with a number of measurement difficulties since its measurement reflects the choice of words, not policies. And forming the fiscal gap–the imbalance in the government's intertemporal budget–requires strong discount rate assumptions. An alternative approach, taken here, is specifying a stochastic general equilibrium model and determining via simulation how long it takes for the economy to reach game over–the point where current policy can no longer be maintained. Our simulations, based on an OLG model calibrated to the U.S. economy, produce an average duration to game over of roughly one century, with a 35 percent chance of reaching the fiscal limit in roughly 30 years. The prospect of man-made economic collapse produces large equity premia, like those observed in the data. Our simulations show that both the fiscal gap and the equity premium rise as the economy gets closer to hitting its fiscal limit, suggesting that the fiscal gap and the equity premium may be good indicators of unsustainable policy.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17917.

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Date of creation: Mar 2012
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Publication status: published as Richard W. Evans, Laurence J. Kotlikoff, Kerk L. Phillips. "Game Over: Simulating Unsustainable Fiscal Policy," in Alberto Alesina and Francesco Giavazzi, editors, "Fiscal Policy after the Financial Crisis" University of Chicago Press (2013)
Handle: RePEc:nbr:nberwo:17917

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References

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  1. When is the US going to reach its fiscal limit?
    by Economic Logician in Economic Logic on 2012-04-06 15:12:00
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Cited by:
  1. Kevin x.d. Huang & Hui He & Sheng-ti Hung, 2013. "Substituting Leisure for Health Expenditure: A General Equilibrium-Based Empirical Investigation," Vanderbilt University Department of Economics Working Papers 13-00020, Vanderbilt University Department of Economics.

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