The perils of fiscal feedback rules

Maxime Menuet, Alexandru Minea and Patrick Villieu

Journal of Economic Theory, 2024, vol. 220, issue C

Abstract: This paper introduces a fiscal feedback rule (FFR) in an endogenous growth model with public debt dynamics. We assume that part of the debt burden is covered by tax increases (we name this “sterilization”), while the remaining part is financed by issuing new debt. We show that while low sterilization does not ensure the existence of a long-run steady state, high sterilization can lead to multiple steady states and aggregate instability in the form of local and global indeterminacy, potentially condemning the economy to a low-growth/high-debt trap steady state and long-lasting public debt cycles. By combining econometric estimations and a calibration exercise on developed economies, we highlight that these various perils can occur for empirically plausible values of the sterilization coefficient.

Keywords: Fiscal feedback rules; Sterilization; Economic growth; Public debt; Debt cycles (search for similar items in EconPapers)
JEL-codes: E10 E62 H62 H63 O40 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:220:y:2024:i:c:s0022053124000632

DOI: 10.1016/j.jet.2024.105857

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