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Fiscal Risk and the Portfolio of Government Programs

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  • Samuel G. Hanson
  • David S. Scharfstein
  • Adi Sunderam

Abstract

In this paper, we develop a new model for government cost-benefit analysis in the presence of risk. In our model, a benevolent government chooses the scale of a risky project in the presence of two key frictions. First, there are market failures, which cause the government to perceive project payoffs differently than private households do. This gives the government a "social risk management" motive: projects that ameliorate market failures when household marginal utility is high are appealing. The second friction is that government financing is costly because of tax distortions. This creates a "fiscal risk management" motive: incremental spending that occurs when total government spending is already high is particularly unattractive. A first key insight is that the government's need to manage fiscal risk frequently limits its capacity for managing social risk. A second key insight is that fiscal risk and social risk interact in complex ways. When considering many potential projects, government cost-benefit analysis thus acquires the flavor of a portfolio choice problem. We use the model to explore how the relative attractiveness of two technologies for promoting financial stability—bailouts and regulation—varies with the government's fiscal burden and characteristics of the economy.

Suggested Citation

  • Samuel G. Hanson & David S. Scharfstein & Adi Sunderam, 2016. "Fiscal Risk and the Portfolio of Government Programs," NBER Working Papers 22763, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:22763
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    Cited by:

    1. Valentin Marian ANTOHI & Monica Laura ZLATI, 2017. "The Impact of the Application of the Fiscal Risk Assessment Procedure in Romania," Economics and Applied Informatics, "Dunarea de Jos" University of Galati, Faculty of Economics and Business Administration, issue 3, pages 78-86.

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    More about this item

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • H1 - Public Economics - - Structure and Scope of Government
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate

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