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Public debt and time preferences: Insolvency, excessive saving and in between

  • Tsur, Yacov
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    Democracy tends to cultivate short-sighted politicians, for whom the horizon extends more or less till next election. This feature gives rise to a discrepancy between the time rate of discount of a country’s polity and the interest rates at which the country borrows. I show how this discrepancy induces public debt swelling. Moreover, if the discrepancy exceeds a certain threshold, public debt will accumulate to the point of insolvency and, to make matter worse, this (unfortunate) state of affairs will be approached at a finite time. Conversely, if budget decision makers are so far-sighted that their time rate of discount is smaller than the relevant interest rate, the country becomes an excessive saver. If the polity’s time rate of discount falls neither below the market interest rate nor exceeds it too much, equilibrium will be reached at a debt-to-GDP ratio between insolvency and excessive saving. Economic growth exacerbates the debt accumulation problem, making insolvency more likely compared to a ceteris-paribus stationary economy.

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    File URL: http://purl.umn.edu/137712
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    Paper provided by Hebrew University of Jerusalem, Department of Agricultural Economics and Management in its series Discussion Papers with number 137712.

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    Date of creation: 12 Sep 2012
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    Handle: RePEc:ags:huaedp:137712
    Contact details of provider: Postal: Faculty of Agriculture, Food and Environmental Quality Sciences Hebrew University of Jerusalem, P.O. Box 12, Rehovot 76100
    Phone: 08-9481230
    Fax: 08-9466267
    Web page: http://departments.agri.huji.ac.il/economics/indexe.html

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    1. Gauti B. Eggertsson & Paul Krugman, 2012. "Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach," The Quarterly Journal of Economics, Oxford University Press, vol. 127(3), pages 1469-1513.
    2. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October.
    3. Fernando A. Broner & Alberto Martín & Jaume Ventura, 2006. "Sovereign Risk and Secondary Markets," Working Papers 288, Barcelona Graduate School of Economics.
    4. Alexander Guembel & Oren Sussman, 2009. "Sovereign Debt without Default Penalties," Review of Economic Studies, Oxford University Press, vol. 76(4), pages 1297-1320.
    5. Reinhart, Carmen M. & Rogoff, Kenneth S., 2010. "Growth in a Time of Debt," Scholarly Articles 11129154, Harvard University Department of Economics.
    6. Nicholas Stern, 2008. "The Economics of Climate Change," American Economic Review, American Economic Association, vol. 98(2), pages 1-37, May.
    7. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 339-57, April.
    8. Oren Sussman & Alexander Guembel, 2005. "Sovereign Debt Without Default Penalties," OFRC Working Papers Series 2005fe17, Oxford Financial Research Centre.
    9. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973.
    10. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
    11. Tsur, Yacov & Zemel, Amos, 2001. "The infinite horizon dynamic optimization problem revisited: A simple method to determine equilibrium states," European Journal of Operational Research, Elsevier, vol. 131(3), pages 482-490, June.
    12. Roubini, Nouriel & Sachs, Jeffrey D., 1989. "Political and economic determinants of budget deficits in the industrial democracies," European Economic Review, Elsevier, vol. 33(5), pages 903-933, May.
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