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The Deficit Gamble

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

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, we 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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5015.

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Date of creation: Feb 1995
Date of revision:
Publication status: published as Journal of Money, Credit and Banking, Vol. 30 (November 1998): 699-720.
Handle: RePEc:nbr:nberwo:5015
Note: EFG
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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  1. 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.
  2. 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.
  3. Andrew B. Abel & N. Gregory Mankiw & Lawrence H. Summers & Richard J. Zeckhauser, 1986. "Assessing Dynamic Efficiency: Theory and Evidence," NBER Working Papers 2097, National Bureau of Economic Research, Inc.
  4. Stephen A. O'Connell & Stephen P. Zeldes, . "Rational Ponzi Games," Rodney L. White Center for Financial Research Working Papers 18-86, Wharton School Rodney L. White Center for Financial Research.
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  5. Butkiewicz, James L., 1983. "The market value of outstanding government debt : Comment," Journal of Monetary Economics, Elsevier, vol. 11(3), pages 373-379.
  6. Stephen G. Cecchetti & Pok-sang Lam & Nelson C. Mark, 1988. "Mean Reversion in Equilibrium Asset Prices," NBER Working Papers 2762, National Bureau of Economic Research, Inc.
  7. 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.
  8. 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.
  9. Olivier Jean Blanchard & Philippe Weil, 1992. "Dynamic Efficiency, the Riskless Rate, and Debt Ponzi Games Under Uncertainty," NBER Working Papers 3992, National Bureau of Economic Research, Inc.
  10. Romer, D., 1988. "What Are The Costs Of Excessive Deficits?," Papers 14, Princeton, Woodrow Wilson School - Discussion Paper.
  11. 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.
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