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The Limits of Political Compromise: Debt Ceilings and Political Turnover

Alexandre Cunha and Emanuel Ornelas

No 6429, CESifo Working Paper Series from CESifo Group Munich

Abstract: We study the desirability of limits on the public debt and of political turnover in an economy where incumbents have an incentive to set public expenditures above the socially optimal level due to rent-seeking motives. Parties alternate in office and cannot commit to future policies, but they can forge a political compromise where each party curbs excessive spending when in office if it expects future governments to do the same. In contrast to the received literature, we find that strict limits on government borrowing can exacerbate political economy distortions by making a political compromise unsustainable. This tends to happen when political turnover is limited. Conversely, a tight limit on the public debt fosters a compromise that yields the efficient outcome if political turnover is vigorous. Our analysis thus suggests that to sustain good economic policies, a society needs to restrict either the extent of political turnover or the ability of governments to issue debt, but not both.

Keywords: debt limits; political turnover; efficient policies; fiscal rules (search for similar items in EconPapers)
JEL-codes: E61 E62 H30 H63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cdm, nep-mac and nep-pol
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
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Journal Article: The Limits of Political Compromise: Debt Ceilings and Political Turnover (2018) Downloads
Working Paper: The Limits of Political Compromise: Debt Ceilings and Political Turnover (2017) Downloads
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