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The Deficit Gamble

Author

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  • Laurence Ball
  • Douglas W. Elmendorf
  • N. Gregory Mankiw

Abstract

The historical behavior of interest rates and growth rates in U.S. data suggests that the government can, with a high probability, run temporary budget deficits and then roll over the resulting government debt forever. The purpose of this paper is to document this finding and to examine its implications. Using a standard overlapping-generations model of capital accumulation, the authors show that whenever a perpetual rollover of debt succeeds, policy can make every generation better off. This conclusion does not imply that deficits are good policy, for an attempt to roll over debt forever might fail. But the adverse effects of deficits, rather than being inevitable, occur with only a small probability.
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Suggested Citation

  • Laurence Ball & Douglas W. Elmendorf & N. Gregory Mankiw, 1995. "The Deficit Gamble," Harvard Institute of Economic Research Working Papers 1710, Harvard - Institute of Economic Research.
  • Handle: RePEc:fth:harver:1710
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    References listed on IDEAS

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    1. Butkiewicz, James L., 1983. "The market value of outstanding government debt : Comment," Journal of Monetary Economics, Elsevier, vol. 11(3), pages 373-379.
    2. Andrew B. Abel & N. Gregory Mankiw & Lawrence H. Summers & Richard J. Zeckhauser, 1989. "Assessing Dynamic Efficiency: Theory and Evidence," Review of Economic Studies, Oxford University Press, vol. 56(1), pages 1-19.
    3. Cass, David, 1972. "On capital overaccumulation in the aggregative, neoclassical model of economic growth: A complete characterization," Journal of Economic Theory, Elsevier, vol. 4(2), pages 200-223, April.
    4. Peled, Dan, 1982. "Informational diversity over time and the optimality of monetary equilibria," Journal of Economic Theory, Elsevier, vol. 28(2), pages 255-274, December.
    5. Blanchard Olivier & Weil Philippe, 2001. "Dynamic Efficiency, the Riskless Rate, and Debt Ponzi Games under Uncertainty," The B.E. Journal of Macroeconomics, De Gruyter, vol. 1(2), pages 1-23, November.
    6. Benjamin M. Friedman, 1978. "Crowding Out or Crowding In? Economic Consequences of Financing Government Deficits," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 9(3), pages 593-641.
    7. David Romer, 1988. "What are the Costs of Excessive Deficits?," NBER Chapters,in: NBER Macroeconomics Annual 1988, Volume 3, pages 63-110 National Bureau of Economic Research, Inc.
    8. Bohn, Henning, 1991. "The Sustainability of Budget Deficits with Lump-Sum and with Income-Based Taxation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 580-604, August.
    9. O'Connell, Stephen A & Zeldes, Stephen P, 1988. "Rational Ponzi Games," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 29(3), pages 431-450, August.
    10. repec:cdl:ucsbec:8-93 is not listed on IDEAS
    11. Bohn, Henning, 1999. "Fiscal Policy and the Mehra-Prescott Puzzle: On the Welfare Implications of Budget Deficits When Real Interest Rates Are Low," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(1), pages 1-13, February.
    12. Cecchetti, Stephen G & Lam, Pok-sang & Mark, Nelson C, 1990. "Mean Reversion in Equilibrium Asset Prices," American Economic Review, American Economic Association, vol. 80(3), pages 398-418, June.
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