The Limits of Political Compromise: Debt Ceilings and Political Turnover

Emanuel Ornelas and Alexandre Cunha

No 11945, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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; Efficient policies; Political turnover; Fiscal rules (search for similar items in EconPapers)
JEL-codes: E61 E62 H30 H63 (search for similar items in EconPapers)
Date: 2017-03
New Economics Papers: this item is included in nep-cdm, nep-mac, nep-pbe and nep-pol
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Journal Article: The Limits of Political Compromise: Debt Ceilings and Political Turnover (2018)
Working Paper: The Limits of Political Compromise: Debt Ceilings and Political Turnover (2017)
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