Working Paper: NBER ID: w29707
Authors: Atif R. Mian; Ludwig Straub; Amir Sufi
Abstract: This paper proposes a tractable framework to analyze fiscal space and the dynamics of government debt, with a possibly binding zero lower bound (ZLB) constraint. Without the ZLB, a greater primary deficit unambiguously raises debt. However, debt need not explode: When R < G – φ, where φ is the sensitivity of R – G to debt, a modest permanent increase in the deficit can be sustained forever, a policy we call “free lunch”. With the ZLB, the relationship between deficit and debt can become non-monotone. Both high and low deficits can increase debt, as the latter weaken demand and reduce nominal growth at the ZLB. A rise in income inequality expands fiscal space outside the ZLB, but contracts it at the ZLB. Calibrating the model, we find little space for “free lunch” policies for the United States in 2019, but ample space for Japan.
Keywords: Fiscal Deficits; Government Debt; Zero Lower Bound; Income Inequality
JEL Codes: E31; E62; H30; H62; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| r < g (C29) | permanent increase in primary deficit can be sustained without leading to explosive debt dynamics (E62) |
| greater deficits at ZLB (E62) | reduce debt levels (H63) |
| r < g - ε (C29) | existence of free lunch (H49) |
| increased income inequality (D31) | expand fiscal space outside the ZLB (E62) |
| increased income inequality (D31) | reduce fiscal space at the ZLB (E62) |
| macro conditions and structural factors (E66) | influence dynamics of debt and deficits (E62) |