A Goldilocks Theory of Fiscal Deficits

80 Pages Posted: 3 Feb 2022

See all articles by Atif R. Mian

Atif R. Mian

Princeton University - Department of Economics; Princeton University - Princeton School of Public and International Affairs; NBER

Ludwig Straub

Harvard University - Department of Economics

Amir Sufi

University of Chicago - Booth School of Business; NBER

Multiple version iconThere are 2 versions of this paper

Date Written: January 31, 2022

Abstract

This paper proposes a tractable framework to analyze fiscal space and the dynamics of government debt, with a possibly binding zero lower bound (ZLB) constraint. Without the ZLB, a greater primary deficit unambiguously raises debt. However, debt need not explode: When R < G – φ, where φ is the sensitivity of R – G to debt, a modest permanent increase in the deficit can be sustained forever, a policy we call “free lunch”. With the ZLB, the relationship between deficit and debt can become non-monotone. Both high and low deficits can increase debt, as the latter weaken demand and reduce nominal growth at the ZLB. A rise in income inequality expands fiscal space outside the ZLB, but contracts it at the ZLB. Calibrating the model, we find little space for “free lunch” policies for the United States in 2019, but ample space for Japan.

JEL Classification: E31,E62,H30,H62,H63

Suggested Citation

Mian, Atif R. and Straub, Ludwig and Sufi, Amir, A Goldilocks Theory of Fiscal Deficits (January 31, 2022). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2022-22, Available at SSRN: https://ssrn.com/abstract=4024624 or http://dx.doi.org/10.2139/ssrn.4024624

Atif R. Mian

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

Princeton University - Princeton School of Public and International Affairs ( email )

Princeton University
Princeton, NJ 08544-1021
United States

NBER

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ludwig Straub

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States

Amir Sufi (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

NBER

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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