Working Paper: CEPR ID: DP12770
Authors: Roger E A Farmer; Pawel Zabczyk
Abstract: We refer to the idea that government must 'tighten its belt' as a necessary policy response to higher indebtedness as the household fallacy. We provide a reason to be skeptical of this claim that holds even if the economy always operates at full employment and all markets clear. Our argument rests on the fact that, in an overlapping-generations (OLG) model, changes in government debt cause changes in the real interest rate that redistribute the burden of repayment across generations. We do not rely on the assumption that the equilibrium is dynamically inefficient, and our argument holds in a version of the OLG model where the real interest rate is always positive.
Keywords: No keywords provided
JEL Codes: E0; H62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government debt (H63) | real interest rate (E43) |
| real interest rate (E43) | Adjustment of savings by young agents (G51) |
| Adjustment of savings by young agents (G51) | Redistribution of repayment burden across generations (H60) |
| government debt (H63) | Redistribution of repayment burden across generations (H60) |