Quantifying the Distortionary Fiscal Cost of 'The Bailout'

45 Pages Posted: 28 Jul 2010

See all articles by Francisco Gomes

Francisco Gomes

London Business School

Alexander Michaelides

Imperial College Business School; Centre for Economic Policy Research (CEPR)

Valery Polkovnichenko

Federal Reserve Board - Divison of Research and Statistics

Date Written: August 2010

Abstract

We utilize an overlapping generations model with endogenous production and incomplete markets to quantify the distortionary costs associated with financing the increase in government expenditures directed to investments in the private sector in 2008 and 2009 (a.k.a. 'the bailout'), and its differential impact on different groups of the population (in the U.S.A.). In our baseline calibration, this distortion corresponds to a loss of approximately $300 billion dollars in total household consumption. For plausible alternative assumptions regarding both the expected and actual duration of this increase in expenditures, or the willingness of foreign institutions and/or investors in absorbing additional government debt, this number can increase to $800 billion. We find that the cost falls more dramatically on those households which are either older and/or wealthier. Retirees face approximately 50% of the cost, as younger agents are more likely to still be alive when the economy has returned to its steady-state. Across wealth groups, the top 25% of the wealth distribution bears almost two thirds of the cost.

Keywords: Bailout, Fiscal Policy, Government Debt, Incomplete Financial Markets., Tax Distortions

JEL Classification: E21, E62, G12

Suggested Citation

Gomes, Francisco and Michaelides, Alexander and Polkovnichenko, Valery, Quantifying the Distortionary Fiscal Cost of 'The Bailout' (August 2010). CEPR Discussion Paper No. DP7941. Available at SSRN: https://ssrn.com/abstract=1649889

Francisco Gomes (Contact Author)

London Business School ( email )

Institute of Finance and Accounting
Sussex Place - Regent's Park
London NW1 4SA
United Kingdom
+44 20 7262 5050 (Phone)
+44 20 7724 3317 (Fax)

HOME PAGE: http://www.london.edu/faculty/fgomes

Alexander Michaelides

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Valery Polkovnichenko

Federal Reserve Board - Divison of Research and Statistics ( email )

20th and C Streets, NW
Washington, DC 20551
United States

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