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The Political Economy of Public Debt: A Laboratory Study

Marco Battaglini (), Salvatore Nunnari () and Thomas R Palfrey

No 13097, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper reports the results from a laboratory experiment designed to study political distortions in the accumulation of public debt. A legislature bargains over the levels of a public good and of district specific transfers in two periods. The legislature can issue or purchase risk-free bonds in the first period and the level of public debt creates a dynamic linkage across policymaking periods. In line with the theoretical predictions, we find that public policies are inefficient and efficiency is increasing in the size of the majority requirement, with higher investment in public goods and lower debt associated with larger majority requirements. Debt is lower when the probability of a negative shock to the economy in the second period is higher indicating that even in a political equilibrium debt is used to smooth consumption and to insure against political uncertainty. Finally, also in line with the theoretical predictions, we find that dynamic distortions are eliminated independently of the voting rule when the first period majority can commit to a policy for the second period. The experiment however highlights two phenomena that are surprising in terms of standard theory and have not been previously documented. First, balancing the budget in each period is a focal point, leading to lower distortions than predicted. Second, higher majority requirements induce significant delays in reaching an agreement.

Keywords: Bargaining; Dynamic Political Economy; Laboratory experiments; public debt (search for similar items in EconPapers)
JEL-codes: C78 C92 D71 D72 H41 H54 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cdm, nep-exp and nep-pol
Date: 2018-08
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Working Paper: The Political Economy of Public Debt: A Laboratory Study (2016) Downloads
Working Paper: The Political Economy of Public Debt: A Laboratory Study (2016) Downloads
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