Monday, July 20, 2009

Automatic fiscal discipline

Would people who do not care about future generations vote to increase government debt indefinitely? Zheng Song, Kjetil Storesletten and Fabrizio Zilibotti argue that no, even in an environment where there is no possible commitment to future fiscal policy.

How is this possible? Take a simple 2-period overlapping generations model where people work when young and save for retirement when old. They are taxed for the provision of a public good that they care about. Each agent votes twice, as young and as old, for fiscal policy: the tax and the provision of the public good (and thus the deficit).

Because the young ones worry about the provision of public goods in the future, they want to impose some fiscal discipline. This is exacerbated as taxes (which are increasing over time) become more distortionary. Also, when debt is already high, the young ones realize that their future public goods will be low, thus they make sure debt is reduced so that a proper quantity of public goods will be provided. In some sense, this is the inverse of the "starving the governement" argument that the second Bush administration seems to have advocated. But then, it may not have cared about public goods.

PS: I was off the Internet for two weeks. I appreciate all the concern about my absence and should have warned my readers. However, I can only recommend getting completely off the Internet for some time. It shows how dependent (or addicted) we have become.

No comments: