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Myopic governments and welfare-enhancing debt limits

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  • Rieth, Malte

Abstract

This paper studies welfare effects of a soft borrowing constraint on sovereign debt. The constraint is modeled as a proportional fine per unit of debt in excess of a specified reference value, resembling features of the Stability and Growth Pact. Sovereign debt is the result of myopic fiscal policy. It reduces welfare in the absence of lump-sum taxes. The paper shows that the borrowing constraint enhances welfare by reducing long run debt. In an economy calibrated to a generic OECD country, the maximum attainable welfare gain of debt consolidation, which is induced by imposing the optimally parameterized constraint, amounts to 0.5% in terms of consumption. The short run welfare costs of the constraint, which arise from restricting the use of debt to smooth taxes, are quantitatively negligible.

Suggested Citation

  • Rieth, Malte, 2014. "Myopic governments and welfare-enhancing debt limits," Journal of Economic Dynamics and Control, Elsevier, vol. 38(C), pages 250-265.
  • Handle: RePEc:eee:dyncon:v:38:y:2014:i:c:p:250-265
    DOI: 10.1016/j.jedc.2013.10.008
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    Cited by:

    1. Luca Guerrieri & Matteo Iacoviello & Raoul Minetti, 2013. "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.
    2. Everett Grant, 2016. "Exposure to international crises: trade vs. financial contagion," ESRB Working Paper Series 30, European Systemic Risk Board.
    3. Mayank GUPTA, 2015. "Revisiting Neoclassical Economic Growth: A Survey in the Literature," Journal of Economics and Political Economy, KSP Journals, vol. 2(1), pages 118-136, March.
    4. Bursian, Dirk, 2016. "Solving RE models with discontinuous policy rules: An application to minimum wage setting in Germany," Discussion Papers 35/2016, Deutsche Bundesbank.
    5. Pietro Cova & Patrizio Pagano & Massimiliano Pisani, 2014. "Foreign exchange reserve diversification and the "exorbitant privilege"," Temi di discussione (Economic working papers) 964, Bank of Italy, Economic Research and International Relations Area.

    More about this item

    Keywords

    Myopic governments; Debt bias; Fiscal constraints; Stability and Growth Pact; Social welfare;

    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents

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