Working Paper: NBER ID: w21948
Authors: Alessandro Dovis; Mikhail Golosov; Ali Shourideh
Abstract: We study optimal fiscal and redistributive policies in an open economy without commitment. Due to its redistributive motives, the government’s incentive to default on its external debt is affected by inequality. We show that in equilibrium the economy endogenously fluctuates between two regimes. In the first regime, the government borrows from abroad, spends generously on transfers and keeps the inequality low. In the second regime, it implements austerity-like policies by cutting transfers, reducing foreign debt and increasing the inequality. The equilibrium dynamics resembles the populist cycles documented in many developing countries.
Keywords: Sovereign Debt; Populism; Austerity; Fiscal Policy; Inequality
JEL Codes: E60; F30; F34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| external debt (F34) | future government policies (H59) |
| inequality (D63) | government's ability to commit to future policies (E60) |
| low inherited external debt (F34) | borrow more and reduce inequality (F65) |
| high external debt (F34) | austerity measures and increased inequality (E65) |
| current debt increases (H63) | future government's preferences lead to decrease in future debt levels (H63) |
| current external debt (F34) | future external debt levels (F34) |