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

34 Pages Posted: 20 Jan 2012

See all articles by Zheng Michael Song

Zheng Michael Song

University of Chicago

Kjetil Storesletten

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Fabrizio Zilibotti

Yale University; Centre for Economic Policy Research (CEPR)

Date Written: January 2012

Abstract

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, i.e., 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.

Keywords: Fiscal discipline, Fiscal policy, General equilibrium, Government debt, High debt in Greece and Italy, Intergenerational conflict, Markov equilibrium, Political economy, Public goods, Repeated voting

JEL Classification: D72, E62, H41, H62, H63

Suggested Citation

Song, Zheng Michael and Storesletten, Kjetil and Zilibotti, Fabrizio, Rotten Parents and Disciplined Children: A Politico-Economic Theory of Public Expenditure and Debt (January 2012). CEPR Discussion Paper No. DP8738, Available at SSRN: https://ssrn.com/abstract=1988670

Zheng Michael Song (Contact Author)

University of Chicago ( email )

Kjetil Storesletten

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

Fabrizio Zilibotti

Yale University ( email )

New Haven, CT 06520
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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