Persistent Government Debt and Risk Distribution

Mariano Croce, Thien Nguyen and Steve Raymond
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Mariano Croce: Finance Department, Bocconi University; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); University of North Carolina Kenan-Flagler Business School
Thien Nguyen: Ohio State University (OSU) - Department of Finance
Steve Raymond: University of North Carolina (UNC) at Chapel Hill - Department of Economics

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: Does it matter whether a government is prompt or slow in consolidating outstanding debt? We address this question by studying the connection between the time variation of the persistence of government-debt-to-output ratio, macroeconomic activity, and asset prices. In the US, when government debt is sluggish, consumption exhibits lower expected growth, more long-run uncertainty, and more long-run downside risk. Simultaneously, the risk premium on the consumption claim (Koijen et al. (2010), Lustig et al. (2013)) increases and features more positive (adverse) skewness. We rationalize these findings in an endogenous growth model in which (i) fiscal policy is distortionary, (ii) the value of innovation depends on fiscal risk, and (iii) the representative agent is sensitive to the resulting distribution of consumption risk. Our model suggests that committing to a rapid reduction of the debt-to-output ratio can enhance the value of innovation, aggregate wealth, and hence welfare.

JEL-codes: E62 G1 H2 H3 (search for similar items in EconPapers)
Date: 2018-11
New Economics Papers: this item is included in nep-dge, nep-mac and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:ecl:ohidic:2019-02

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