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Myopic Governments and Welfare-Enhancing Debt Limits

Aufsätze referiert extern - Web of Science

Malte Rieth

In: Journal of Economic Dynamics & Control 38 (2014), S. 250-265


This paper studies welfare effects of a soft borrowing constraint on sovereign debt. The constraint is modeled as a proportional fine per unit of debt in excess of a specified reference value, resembling features of the Stability and Growth Pact. Sovereign debt is the result of myopic fiscal policy. It reduces welfare in the absence of lump-sum taxes. The paper shows that the borrowing constraint enhances welfare by reducing long run debt. In an economy calibrated to a generic OECD country, the maximum attainable welfare gain of debt consolidation, which is induced by imposing the optimally parameterized constraint, amounts to 0.5% in terms of consumption. The short run welfare costs of the constraint, which arise from restricting the use of debt to smooth taxes, are quantitatively negligible.

Malte Rieth

Research Associate in the Macroeconomics Department

Topics: Public finances

JEL-Classification: E6;H3
Keywords: Myopic governments, Debt bias, Fiscal constraints, Stability and Growth Pact, Social welfare