- Are deficits free?
- Johannes Brumm, Xiangyu Feng, Laurence Kotlikoff, Felix Kubler
- Journal of Public Economics Volume 208, April 2022, 104627
- #002603 20220609 () Views:53078
- Deficit finance, a.k.a. pay-go policy, is free when growth rates routinely exceed safe government borrowing rates. Or so many say. This note presents four counterexamples based on four versions of a simple OLG economy. In each version the growth rate exceeds the safe rate for one of four reasons – uninsured idiosyncratic risk, uninsured aggregate risk, policy uncertainty, and imperfect financial intermediation. Deficit finance does not directly address any of these problems. What works, respectively speaking, is progressive taxation, bilateral intergenerational risk-sharing, early policy resolution, and improved intermediation. The four examples thus show that seemingly free deficits may be more costly than they appear. Indeed, inefficient pay-go policy can even lower the government’s borrowing rate, encouraging yet more deficit finance.
- Keywords: Deficits; Dynamic inefficiency; Fiscal policy; Interest rates; Intergenerational risk sharing; Pay-go social security; Ponzi schemes; Public debt; Social security
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