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Debt stability under entitlement spending

Listed author(s):
  • Floriana, Cerniglia
  • Enzo, Dia
  • Andrew, Hughes Hallett

Economists have traditionally used a simple rule that restricts primary deficits to less than a threshold given by the interest rate-growth rate differential and existing debt level to judge fiscal sustainability. This rule derives from a single period application of the government's budget constraint. It does not allow for the predictable dynamic effects of spending liabilities, such as entitlement spending. In this paper, we derive the equivalent dynamic rule for this case. It still depends on the interest-growth rate differential, but now includes a restriction on spending growth in relation to income growth. Several new results emerge. Debt remains stable; but the rate of convergence to stability varies with different parameters. And the growth in spending has to be less than a damping factor that controls convergence. This puts a limit on spending growth. To penalize the use of unpopular taxes further limits debt and the incentive to use debt finance.

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File URL: http://dems.unimib.it/repec/pdf/mibwpaper351.pdf
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Paper provided by University of Milano-Bicocca, Department of Economics in its series Working Papers with number 351.

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Length: 34
Date of creation: 07 Oct 2016
Date of revision: 07 Oct 2016
Handle: RePEc:mib:wpaper:351
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  1. Atish R. Ghosh & Jun I. Kim & Enrique G. Mendoza & Jonathan D. Ostry & Mahvash S. Qureshi, 2013. "Fiscal Fatigue, Fiscal Space and Debt Sustainability in Advanced Economies," Economic Journal, Royal Economic Society, vol. 0, pages 4-30, 02.
  2. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-971, October.
  3. Fisher, P. G. & Hallett, A. J. Hughes, 1988. "Efficient solution techniques for linear and non-linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 12(4), pages 635-657, November.
  4. Hughes Hallett, A. J., 1979. "Computing revealed preferences and limits to the validity of quadratic objective functions for policy optimization," Economics Letters, Elsevier, vol. 2(1), pages 27-32.
  5. Bohn, Henning, 1990. "Tax Smoothing with Financial Instruments," American Economic Review, American Economic Association, vol. 80(5), pages 1217-1230, December.
  6. Robert J. Barro & Charles J. Redlick, 2011. "Macroeconomic Effects From Government Purchases and Taxes," The Quarterly Journal of Economics, Oxford University Press, vol. 126(1), pages 51-102.
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