Working Paper: CEPR ID: DP13922
Authors: Mariano Massimiliano Croce; Thien Nguyen; Steve Raymond
Abstract: When government debt is sluggish, consumption exhibits lower expected growth, morelong-run uncertainty, and more long-run downside risk. Simultaneously, the risk premiumon the consumption claim (Koijen et al. (2010), Lustig et al. (2013)) increasesand features more positive (adverse) skewness. We rationalize these fi ndings in an endogenousgrowth model in which fi scal policy is distortionary, the value of innovationdepends on fiscal risk, and the representative agent is sensitive to the resulting distributionof consumption risk. Our model suggests that committing to a rapid reductionof the debt-to-output ratio can enhance the value of innovation, aggregate wealth, andwelfare.
Keywords: Fiscal Policy; Endogenous Growth; Risk; Asset Prices
JEL Codes: E62; G1; H2; H3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government debt is sluggish (H63) | lower expected long-term growth (O49) |
| government debt is sluggish (H63) | increase in long-run risk (G19) |
| government debt is sluggish (H63) | worsening distribution of consumption risk (D39) |
| lower expected long-term growth (O49) | increase in risk premium on consumption claims (D11) |
| lower expected long-term growth (O49) | more positive adverse skewness in consumption risk (D11) |
| commitment to reducing the debt-to-output ratio (H63) | enhance the value of innovation (O35) |
| commitment to reducing the debt-to-output ratio (H63) | enhance aggregate welfare (D69) |
| countercyclical tax policies (H39) | costly decline in innovation incentives (O39) |
| countercyclical tax policies (H39) | decline in long-run growth (O49) |
| tax smoothing aimed at long-term stabilization (H21) | improve growth (O49) |
| tax smoothing aimed at long-term stabilization (H21) | enhance welfare (I30) |
| less aggressive policy of debt consolidation (G51) | stabilize the economy (E63) |
| less aggressive policy of debt consolidation (G51) | slower future growth (O49) |
| less aggressive policy of debt consolidation (G51) | increased long-run consumption risk (D15) |