Government Debt Threshold Contracts

39 Pages Posted: 14 Nov 2010

See all articles by Hans Gersbach

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Reseaarch; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

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Date Written: September 2010

Abstract

Politicians tend to push the amount of public debt beyond socially desirable levels in order to increase their reelection chances. We develop a model that provides a new explanation for this behavior: office holders undertake debt-financed public projects, but postpone the timing of part of the output to the next term. This makes it difficult to replace them. As a consequence, the office-holders' reelection chances rise -- as does public debt. As a potential remedy for this inefficiency, we allow candidates for public office to offer government debt-threshold contracts. Such a contract contains an upper limit for government debt and the sanction that an office-holder violating this limit cannot stand for reelection. We show that such competitively-offered contracts contain low debt levels that limit debt financing and improve the citizens' welfare. When negative macroeconomic events occur, government debt contracts may be violated, and such shocks are stabilized.

Keywords: Elections, Government Debt, Macroeconomic Shocks, Political Contracts

JEL Classification: D7, D82, H4

Suggested Citation

Gersbach, Hans, Government Debt Threshold Contracts (September 2010). CEPR Discussion Paper No. DP8001. Available at SSRN: https://ssrn.com/abstract=1707891

Hans Gersbach (Contact Author)

ETH Zurich - CER-ETH -Center of Economic Reseaarch ( email )

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Zurich, 8092
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IZA Institute of Labor Economics

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Germany

CESifo (Center for Economic Studies and Ifo Institute)

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Centre for Economic Policy Research (CEPR)

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United Kingdom

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