Rising Government Debt: Causes and Solutions for a Decades-Old Trend
44 Pages Posted: 31 Aug 2018 Last revised: 1 Jan 2019
Date Written: December 31, 2018
Over the past four decades, government debt as a fraction of GDP has been on an upward trajectory in advanced economies, approaching levels not reached since World War II. While normative macroeconomic theories can explain the increase in the level of debt in certain periods as a response to macroeconomic shocks, they cannot explain the broad-based long-run trend in debt accumulation. In contrast, political economy theories can explain the long-run trend as resulting from an aging population, rising political polarization, and rising electoral uncertainty across advanced economies. These theories emphasize the time-inconsistency in government policymaking, and thus the need for fiscal rules that restrict policymakers. Fiscal rules trade off commitment to not overspend and flexibility to react to shocks. This tradeoff guides design features of optimal rules, such as information dependence, enforcement, cross-country coordination, escape clauses, and instrument vs. target criteria.
Keywords: Institutions, Public Debt, Optimal Taxation, Fiscal Policy, Political Economy, Fiscal Rules, Delegation, Commitment vs. Flexibility, Hyperbolic Preferences
JEL Classification: D02, H63, H21, E62, P6
Suggested Citation: Suggested Citation