Myopic governments and welfare-enhancing debt limits

Malte Rieth ()

Journal of Economic Dynamics and Control, 2014, vol. 38, issue C, 250-265

Abstract: 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.

Keywords: Myopic governments; Debt bias; Fiscal constraints; Stability and Growth Pact; Social welfare (search for similar items in EconPapers)
JEL-codes: E6 H3 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (15)

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Working Paper: Myopic governments and welfare-enhancing debt limits (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:38:y:2014:i:c:p:250-265

DOI: 10.1016/j.jedc.2013.10.008

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