Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
The political economy of government debt Advanced Political Economics Fall 2011 Riccardo Puglisi Main Questions Why do we observe such large differences in public debt policies across countries and within one country across time? Optimal taxation and Ricardian equivalence provide no valid intution Idea (guess what) We need to link debt policy to political environment Political Environment Debt Policy Different solutions: •Debt issue changes the incentives for future policy makers • • PERSSON-SVENSON (QJE 1989): different expenditure levels • TABELLINI-ALESINA (AER 1990): different expenditure composition Debt redistributes across generations-TABELLINI (JPE 1991) • Weak Government do not control the expenditure: common pool problem -VELASCO 1992 • Budget institutions matter -ALESINA-PEROTTI (1996) TABELLINI-ALESINA (AER 1990) “Voting on the budget deficit” Different majorities may differ in their desired composition of government consumption. If the current majority can be replaced by a different majority in the future, the current one can have the incentive to favor budget deficit in order to influence future decisions. Deficit as a state variable which affects future policy decisions PREDICTION: Political instability induces larger deficits The model: 1. Heterogenous agents decide on two public goods (f, g) 2. Two-period economy 3. The economy is endowed with one unit of output each period 4. Small-open economy borrowing/lending takes place at a given interest rate, equal in the two periods HP: The debt has to be fully repaid at the end of the second period •Budget constraints: g1 f1 1 b g2 f 2 1 b with f>0 and g>0, in any period, and b (1,1) •Preferences for agent i 2 w E ( i u ( g t ) (1 i )u ( f t ) ) i t 1 with u () concave, strictly increasing and i distributed [0,1] Notice that these are intermediate-preferences over (f,g). We can apply Median voter theorem. Voting behavior 1. At the beginning of each period, voters choose (g,f) 2. No pre-commitment device Bidimensional voting in period 1 Unidimensional voting in period 2 To determine the political equilibrium we use backward induction LAST PERIOD: 2 is the median voter in period 2 m The problem is max 2 u ( g 2 ) (1 2 )u ( f 2 ) under the constraint m g2 f 2 1 b m FOC: 2 u ' ( g 2 ) (1 2 )u ' (1 b g 2 ) 0 m m That defines implicitly: g 2* G ( 2 m , b) * * m f 1 b g F ( 2 2 2 , b) Notice that, 2 1 g2 1 b f2 0 m * * 2 0 g2 0 f2 1 b m * * We move back to the first period... The problem here is: E max 1 u ( g1 ) (1 1 )u (1 b g1 ) m m g1 ,b m 1 u (G ( 2 , b)) (1 1 )u ( F ( 2 , b)) m m m Notice that the decision over b has both a direct impact and a strategic one. The higher b today, the lower will be the income at disposal tomorrow. FOC •With respect to g1 1 u ' ( g1 ) (1 1 )u ' (1 b g1 ) 0 m m that defines g g (1 , b) * 1 m f f (1 , b) * 1 m such that f (1, b) g (0, b) 0 * 1 * 1 f1 (0, b) g1 (1, b) 1 b * * •With respect to b 1mu ' ( g1 (1m , b) E 1mu ' (G ( 2 m , b))Gb (1 1m )u ' ( F ( 2 m , b)) Fb 0 Marginal Gain of b Marginal Cost of b INTUITION: An increase on debt today, increases your consumption today but decreases it tomorrow. The higher is the distance on preferences between today and tomorrow majority, the higher will be the incentive for today majority to issue debt. Solution To solve the game, we have to impose some restrictions on the distribution of α CASE I 1m 2 m m In case we have always the same median voter we can rewrite the FOC in the first period as: u' ( g ( m m , b)) E m u' (G( , b)) m Because of the last period FOC and because of the budget constraint: f 2 g 2 f2 g2 1 b 1 b b This situation implies b=0 INTUITION: If median voter today and tomorrow have identical preferences, there is no incentive to debt issue CASE II 1 2 m m with positive probability m m 1 2 0 (A) Consider the case that either 2 In this case, we know that in the second period 2m 0 f2 1 b 2m 1 f2 1 b PROP. 1: (i) If either 2 m 1 2 m 0, then b*>0 (ii) b* is greater m the larger is the difference between 1 and the expected value of 2 m INTUITION: Again an increase in today’s debt increases utility today but decreases tomorrow spending. However, with positive probability, this reduction will only affect the good the median voter cares little ( no fully internalization of costs) (B) Consider that c.d.f. H( ) 2 (0,1) and it is distributed according to the m Then, the FOC for the first period becomes: 1 1 u ( g ) v( 2 )dH ( 2 ) u ( g ) v( 2 ) dH ( 2 ) m ' 1 Where * 1 m m 0 0 m ' 1 * 1 m m u ' ( g 2 )u ' ( f 2 ) 1 ( f 2 ) (1 1 ) ( g 2 ) m v( 2 ) * * * * u ' ( g 2 ) ( g 2 ) u ' ( f 2 ) ( f 2 ) * * m * and λ is a concavity index on the utility, such that: u ' ' () () u ' ()2 m * HP: The concavity index of u(x), λ(x) is decreasing in x, for any x (0,1) An example of function that satisfies this condition is u ( x) x m PROP. 2: Given 2 (0,1) , then b*>0 if the above assumption is satisfied Idea of the proof (sketchy): At b=0, the FOC is still positive, meaning 1 u ( g ) v( 2 ) 0 m ' * 1 m then, the optimal level of debt must be positive. DEF (Polarization): The probability distribution H(α) is more polarized relative to α than K(α), if for any continous increasing function f( ), the following condition is true: 1 0 1 f ( | 2 1 |) dH ( 2 ) f ( | 2 1 |) dK ( 2 ) m m m m m m 0 The idea is that a more polarized distribution assigns more weight to values of 2 m that are more further away from 1m PROP. 3: If the hypothesis is satisfied, b* is larger the more polarized is the probability distribution of 2 m relative to 1m over the interval (0,1) NOTICE: The opposite of proposition 2 and 3 is true for λ increasing •The downward sloping line is the budget constraint if b=0 •A and B are the point m chosen by 1 and 2 m at b=0 •u1 and u2 are the indifference curves of one individual in the two periods •EP1 and EP2 are the income expansion paths of the two types EP2 u2 B u1 A EP1 Intuition Then, in general, at b=0, there are two opposing effects of a change in b: 1. If b<0 (surplus), less income in the first period and more income in the second. Then, u1 moves to the left and u2 to the right; equivalent to buy an insurance 2. If b>0 (deficit), more income in the first and less in the second. u1 moves to the right and u2 to the left. Add more consumption today, when the median voter decides the composition of spending, and decrease consumption tomorrow. If the condition on the concavity index is satisfied (2)>(1) DEFICIT Positive implications 1. The greater the instability, the larger the deficit 2. The greater polarization, the larger the deficit