Econometrica: Nov 2012, Volume 80, Issue 6

Rotten Parents and Disciplined Children: A Politico‐Economic Theory of Public Expenditure and Debt

https://doi.org/10.3982/ECTA8910
p. 2785-2803

Zheng Song, Kjetil Storesletten, Fabrizio Zilibotti

This paper proposes a dynamic politico‐economic theory of fiscal policy in a world comprising a set of small open economies, whose driving force is the intergenerational conflict over debt, taxes, and public goods. Subsequent generations of voters choose fiscal policy through repeated elections. The presence of young voters induces fiscal discipline, that is, low taxes and low debt accumulation. The paper characterizes the Markov‐perfect equilibrium of the voting game in each economy, as well as the stationary equilibrium debt distribution and interest rate of the world economy. The equilibrium can reproduce some salient features of fiscal policy in modern economies.
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Supplement to "Rotten Parents and Disciplined Children: A Politico-Economic Theory of Public Expenditure and Debt"

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Supplement to "Rotten Parents and Disciplined Children: A Politico-Economic Theory of Public Expenditure and Debt"

This PDF provides the politico-economic microfoundations of the model.  Section B2 provides the derivation of equation (9). Section B3 provides the proof of Proposition 2.  Section B4 extends the analysis under CRRA utility.  Section B5 shows the result of numerical analysis using the alternative method of Krusell et al. (2002).  Finally, Section B6 shows the details of the numerical analysis of a demographic transition such as the one discussed in the text.

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