Munich Personal RePEc Archive

Borrowing to Finance Public Investment: A Politico-economic Analysis of Fiscal Rules

Uchida, Yuki and Ono, Tetsuo (2021): Borrowing to Finance Public Investment: A Politico-economic Analysis of Fiscal Rules.

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Abstract

The golden rule of public finance distinguishes public investment from consumption spending when borrowing, permitting the finance of public investment only. This study focuses on public investment in human capital and compares this rule with the balanced budget rule, which rules out debt finance, in an overlapping generations model. In the model, fiscal policy is endogenous, chosen each period by a short-lived government representing existing generations. We evaluate the government's choice and the resulting political distortions for a given fiscal rule from the long-lived planner's perspective. We find that a country with a larger preference for public consumption can minimize distortions by lowering the fraction of debt-financed public investment. We calibrate the model to a sample of OECD countries. On the one hand, we find that the golden rule of public finance in human capital is optimal and politically supported in Greece; on the other hand, the balanced budget rule (no borrowings for human capital investment) is optimal and politically supported in Germany and to a lesser extent in Japan and the United States.

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