Working Paper: NBER ID: w21660
Authors: Marco Battaglini; Levon Barseghyan
Abstract: We present a theory of endogenous fiscal policy and growth. Fiscal policy — debt, income tax, spending on local public goods and public investment — is determined through legislative bargaining. Economic growth depends directly on public investment, private investment in human capital and, via learning-by-doing, labor supply. The model predicts that the economy converges to a balanced growth path in which consumption, private investment, public investment, public goods provision, public debt and productivity grow at the same constant rate. The transition to the balanced growth path is characterized by what we call the shrinking government effect: public debt grows faster than GDP, provisions of public goods and infrastructure grow slower than GDP and the tax rate declines. We use the model to study the impact of austerity programs which impose a ceiling on the amount of public debt a country can issue.
Keywords: Fiscal Policy; Debt; Economic Growth; Austerity Programs; Public Goods
JEL Codes: D72; E6; H6; H72
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high levels of public debt (H69) | economic growth (O49) |
| public debt (H63) | consumption and savings (E21) |
| deficits (H62) | consumption and savings (E21) |
| public debt (H63) | interest rates (E43) |
| austerity programs (E65) | welfare (I38) |
| optimal austerity plans (E63) | economic context (E66) |
| government incentives (O31) | tax cuts and public goods reduction (H49) |
| public investment (H54) | economic growth (O49) |
| private investment in human capital (J24) | economic growth (O49) |
| labor supply (J20) | economic growth (O49) |