Debt Stability Under Entitlement Spending

34 Pages Posted: 9 Oct 2016

See all articles by Floriana Cerniglia

Floriana Cerniglia

University of Milan, Bicocca - Faculty of Economics; Università degli Studi di Milano-Bicocca - Center for Interdisciplinary Studies in Economics, Psychology & Social Sciences (CISEPS); Università degli Studi di Milano-Bicocca - Department of Economics, Management and Statistics (DEMS)

Enzo Dia

Università degli Studi di Milano-Bicocca - Center for Interdisciplinary Studies in Economics, Psychology & Social Sciences (CISEPS); Università degli Studi di Milano-Bicocca - Department of Economics, Management and Statistics (DEMS)

Andrew J. Hughes Hallett

George Mason University - School of Policy, Government, and International Affairs

Date Written: October 7, 2016

Abstract

Economists have traditionally used a simple rule that restricts primary deficits to less than a threshold given by the interest rate growth rate differential and existing debt level to judge fiscal sustainability. This rule derives from a single period application of the government’s budget constraint. It does not allow for the predictable dynamic effects of spending liabilities, such as entitlement spending. In this paper, we derive the equivalent dynamic rule for this case. It still depends on the interest growth rate differential, but now includes a restriction on spending growth in relation to income growth. Several new results emerge. Debt remains stable; but the rate of convergence to stability varies with different parameters. And the growth in spending has to be less than a damping factor that controls convergence. This puts a limit on spending growth. To penalize the use of unpopular taxes further limits debt and the incentive to use debt finance.

Keywords: Sustainable public debt, primary deficit rules, fiscal space

JEL Classification: E62, H53, H63, I38

Suggested Citation

Cerniglia, Floriana and Dia, Enzo and Hughes Hallett, Andrew, Debt Stability Under Entitlement Spending (October 7, 2016). University of Milan Bicocca Department of Economics, Management and Statistics Working Paper No. 351, Available at SSRN: https://ssrn.com/abstract=2849617 or http://dx.doi.org/10.2139/ssrn.2849617

Floriana Cerniglia

University of Milan, Bicocca - Faculty of Economics ( email )

Italy

Università degli Studi di Milano-Bicocca - Center for Interdisciplinary Studies in Economics, Psychology & Social Sciences (CISEPS) ( email )

Piazza dell'Ateneo Nuovo, 1
Milano, 20126
Italy

Università degli Studi di Milano-Bicocca - Department of Economics, Management and Statistics (DEMS) ( email )

Piazza dell'Ateneo Nuovo, 1
Milan, 20126
Italy

Enzo Dia (Contact Author)

Università degli Studi di Milano-Bicocca - Center for Interdisciplinary Studies in Economics, Psychology & Social Sciences (CISEPS) ( email )

Piazza dell'Ateneo Nuovo, 1
Milano, 20126
Italy

Università degli Studi di Milano-Bicocca - Department of Economics, Management and Statistics (DEMS) ( email )

Piazza dell'Ateneo Nuovo, 1
Milan, 20126
Italy

Andrew Hughes Hallett

George Mason University - School of Policy, Government, and International Affairs ( email )

Founders Hall
3351 Fairfax Dr.
Arlington, VA 22201
United States

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