Myopic governments and welfare-enhancing debt limits |
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| Affiliation: | 1. Department of Microbiology III, Faculty of Biology, Complutense University of Madrid Jose Antonio Novais 12, 28040 Madrid, Spain;2. Department of Genetics, Faculty of Biology, Complutense University of Madrid Jose Antonio Novais 12, 28040 Madrid, Spain;1. Institute of Precambrian Geology and Geochronology, nab. Makarova 2, St. Petersburg, 199034, Russia;2. Geological Institute of the Kola Science Center, Russian Academy of Sciences, ul. Fersmana 14, Apatity, Murmansk Region, 184209, Russia;3. Tellur North-East LLC, ul. Soyuza Pechatnikov 8, St. Petersburg, 199000, Russia |
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| Abstract: | This paper studies welfare effects of a soft borrowing constraint on sovereign debt. The constraint is modeled as a proportional fine per unit of debt in excess of a specified reference value, resembling features of the Stability and Growth Pact. Sovereign debt is the result of myopic fiscal policy. It reduces welfare in the absence of lump-sum taxes. The paper shows that the borrowing constraint enhances welfare by reducing long run debt. In an economy calibrated to a generic OECD country, the maximum attainable welfare gain of debt consolidation, which is induced by imposing the optimally parameterized constraint, amounts to 0.5% in terms of consumption. The short run welfare costs of the constraint, which arise from restricting the use of debt to smooth taxes, are quantitatively negligible. |
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| Keywords: | Myopic governments Debt bias Fiscal constraints Stability and Growth Pact Social welfare |
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