Working Paper: CEPR ID: DP18007
Authors: Randolph Sloof; Roel Beetsma; Alina Steinweg
Abstract: Motivated by the recent debate about the EU fiscal framework, we analyse public debt ceilings in a political-economy model with uncertainty about both the type of policymaker (benevolent or selfish) and the state of the economy (good or bad). Pooling, hybrid and separating equilibria may exist. The presence of elections generates disciplining and selection effects, of which the relative importance differs across these equilibria. Shifts in the debt ceiling may lead to switches in the prevailing type of equilibrium, thereby inducing jumps in expected welfare. The optimal debt ceiling trades off the implied distortion in the intertemporal allocation of resources under a benevolent policymaker against excessive debt creation under a self-interested policymaker so as to finance diversion of resources for private use. Increased transparency in terms of voters learning with a higher probability the state of the economy before casting their vote affects neither the optimal ceiling nor expected welfare. If instead increased transparency allows for imposing state-contingent debt ceilings, for instance monitored by an independent fiscal institution, welfare may be improved. We identify the circumstances under which it is optimal to make debt ceilings state-contingent. State-contingent ceilings induce more frequent pooling, resulting in less excessive debt creation. The potential benefits of state-contingency support the greater role that recent European Commission proposals assign to the national independent fiscal institutions and the differentiation in debt reduction paths of EU Member States.
Keywords: Fiscal Transparency; Debt Ceilings; Welfare; Elections; Independent Fiscal Institutions
JEL Codes: D72; D82; E62; H62; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| shifts in the debt ceiling (H63) | changes in the prevailing type of equilibrium (D59) |
| changes in the prevailing type of equilibrium (D59) | jumps in expected welfare (D69) |
| increased transparency regarding the state of the economy (E60) | implementation of state-contingent debt ceilings (H63) |
| implementation of state-contingent debt ceilings (H63) | improvement in welfare by reducing excessive debt creation (F65) |
| state-contingent ceilings (E64) | more frequent pooling (C92) |
| optimal debt ceiling tailored to the economic state (H63) | enhances fiscal discipline while allowing for necessary flexibility (H61) |