Persistent Government Debt and Aggregate Risk Distribution
Charles A. Dice Center Working Paper No. 2019-2
73 Pages Posted: 29 Nov 2018 Last revised: 14 Apr 2020
Date Written: March 26, 2020
When government debt is sluggish, consumption exhibits lower expected growth, more long-run uncertainty, and more long-run downside risk. Simultaneously, the risk premium on the consumption claim (Koijen et al. (2010), Lustig et al. (2013)) increases and features more positive (adverse) skewness. We rationalize these findings in an endogenous growth model in which fiscal policy is distortionary, the value of innovation depends on fiscal risk. Our model suggests that committing to a rapid reduction of the debt-to-output ratio can enhance the value of innovation, aggregate wealth, and welfare.
Keywords: Fiscal Policy, Endogenous Growth Risk, Asset Prices
JEL Classification: E62, G1, H2, H3
Suggested Citation: Suggested Citation