Working Paper: NBER ID: w26177
Authors: Mariano Max Croce; Thien T. Nguyen; Steve Raymond
Abstract: When government debt is sluggish, consumption exhibits lower expected growth, more long-run uncertainty, and more long-run downside risk. Simultaneously, the risk premium on the consumption claim (Koijen et al. (2010), Lustig et al. (2013)) increases and features more positive (adverse) skewness. We rationalize these findings in an endogenous growth model in which fiscal policy is distortionary, the value of innovation depends on fiscal risk, and the representative agent is sensitive to the resulting distribution of consumption risk. Our model suggests that committing to a rapid reduction of the debt-to-output ratio can enhance the value of innovation, aggregate wealth, and welfare.
Keywords: government debt; aggregate risk; fiscal policy; innovation; endogenous growth
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 |
|---|---|
| sluggish government debt (H63) | lower expected growth (O49) |
| sluggish government debt (H63) | increased long-run uncertainty (D89) |
| sluggish government debt (H63) | heightened long-run downside risk (E44) |
| sluggish government debt (H63) | risk premium on consumption claims rises (D11) |
| sluggish government debt (H63) | more adverse skewness (C46) |
| commitment to rapidly reducing debt-to-output ratio (H63) | enhance value of innovation (O35) |
| commitment to rapidly reducing debt-to-output ratio (H63) | increase aggregate wealth (E21) |
| commitment to rapidly reducing debt-to-output ratio (H63) | increase welfare (I38) |
| increased sluggishness in debt-to-output ratio (H69) | deterioration in distribution of consumption risk (D39) |