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Persistent government debt and aggregate risk distribution

M. Croce, Thien T. Nguyen and S. Raymond

Journal of Financial Economics, 2021, vol. 140, issue 2, 347-367

Abstract: 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 fiscal policy is distortionary, the value of innovation depends on fiscal risk, and 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 welfare.

Keywords: Fiscal policy; Endogenous growth risk; Asset prices (search for similar items in EconPapers)
JEL-codes: E62 G10 H20 H30 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:140:y:2021:i:2:p:347-367

DOI: 10.1016/j.jfineco.2021.01.004

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