Future Rent-Seeking and Current Public Savings

34 Pages Posted: 23 Oct 2008 Last revised: 24 Nov 2022

See all articles by Ricardo J. Caballero

Ricardo J. Caballero

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Pierre Yared

Columbia University - Columbia Business School, Finance

Multiple version iconThere are 3 versions of this paper

Date Written: October 2008

Abstract

The conventional wisdom is that politicians' rent-seeking motives increase public debt and deficits. This is because myopic politicians face political risk and prefer to extract political rents as early as possible. An implication of this argument is that governments will under-save during a boom, leaving the economy unprotected in the event of a downturn. This view motivates a number of fiscal rules which are aimed at cutting deficits and constraining borrowing so as to limit the size of this political distortion. In this paper we study the determination of government debt and deficits in a dynamic model of debt which characterizes political distortions. We find that in our model the conventional wisdom always applies in the long run, but only does so in the short run when economic volatility is low. Instead, when economic volatility is high, a rent-seeking government over-saves and over-taxes along the equilibrium path relative to a benevolent government. Paradoxically, the over-saving bias can also be solved in this case by a rule of capping deficits, although the mechanism operates through its effect on expectations of future rent extraction rather than though the contemporary constraint. However, these rules are ineffective in solving the high taxation problem caused by the political friction, which in the short run is more acute in the high income volatility scenario.

Suggested Citation

Caballero, Ricardo J. and Yared, Pierre, Future Rent-Seeking and Current Public Savings (October 2008). NBER Working Paper No. w14417, Available at SSRN: https://ssrn.com/abstract=1288416

Ricardo J. Caballero (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive
Building E52-528
Cambridge, MA 02142
United States
617-253-0489 (Phone)
617-253-1330 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Pierre Yared

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
Uris Hall
New York, NY 10027
United States