Working Paper: NBER ID: w31185
Authors: Georgemarios Angeletos; Chen Lian; Christian K. Wolf
Abstract: We ask how fiscal deficits are financed in environments with two key features: (i) nominal rigidity, and (ii) a violation of Ricardian equivalence due to finite lives or liquidity constraints. In such environments, deficits can contribute to their own financing through two channels: a boom in real economic activity, which expands the tax base; and a surge in inflation, which erodes the real value of nominal government debt. Our main theoretical result establishes that this mechanism becomes more potent as fiscal adjustment is delayed, leading to full self-financing in the limit. In this scenario, the government can run a deficit today, refrain from tax hikes or spending cuts in the future, and still see its debt converge back to its initial level. We further demonstrate that a significant degree of self-financing is achievable when the theory is disciplined by empirical evidence on marginal propensities to consume, nominal rigidities, and the speed of fiscal adjustment.
Keywords: Fiscal Deficits; Self-Financing; Nominal Rigidity; Ricardian Equivalence
JEL Codes: E6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal Deficits (H68) | Economic Activity (R11) |
| Economic Activity (R11) | Tax Revenues (H20) |
| Inflation (E31) | Real Value of Nominal Government Debt (H63) |
| Timing of Fiscal Policy (E62) | Effectiveness of Self-Financing (I22) |
| Fiscal Adjustment Delay (E62) | Economic Boom (N12) |
| Fiscal Deficits (H68) | Self-Financing (G32) |