Working Paper: NBER ID: w24979
Authors: Pierre Yared
Abstract: Over the past four decades, government debt as a fraction of GDP has been on an upward trajectory in advanced economies, approaching levels not reached since World War II. While normative macroeconomic theories can explain the increase in the level of debt in certain periods as a response to macroeconomic shocks, they cannot explain the broad-based long-run trend in debt accumulation. In contrast, political economy theories can explain the long-run trend as resulting from an aging population, rising political polarization, and rising electoral uncertainty across advanced economies. These theories emphasize the time-inconsistency in government policymaking, and thus the need for fiscal rules that restrict policymakers. Fiscal rules trade off commitment to not overspend and flexibility to react to shocks. This tradeoff guides design features of optimal rules, such as information dependence, enforcement, cross-country coordination, escape clauses, and instrument vs. target criteria.
Keywords: government debt; fiscal policy; political economy; economic shocks
JEL Codes: D02; E62; H21; H6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Aging population (J11) | Rising government debt (H69) |
| Rising political polarization (D72) | Rising government debt (H69) |
| Electoral uncertainty (D79) | Rising government debt (H69) |
| Political economy factors (P19) | Rising government debt (H69) |
| Time inconsistency in policymaking (E61) | Rising government debt (H69) |
| Failure of political institutions (P16) | Rising government debt (H69) |
| Fiscal rules (E62) | Mitigation of time inconsistency problem (D15) |
| Increasing government deficits (H69) | Rising government debt (H69) |