Government Debt‐Threshold Contracts

15 Pages Posted: 20 Nov 2013

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)

Multiple version iconThere are 2 versions of this paper

Date Written: January 2014

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‐threshold contracts may be violated, and the economy is stabilized.

JEL Classification: : D7, D82, H4

Suggested Citation

Gersbach, Hans, Government Debt‐Threshold Contracts (January 2014). Economic Inquiry, Vol. 52, Issue 1, pp. 444-458, 2014. Available at SSRN: https://ssrn.com/abstract=2357239 or http://dx.doi.org/10.1111/ecin.12038

Hans Gersbach (Contact Author)

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

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IZA Institute of Labor Economics

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Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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