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.

Abstract

This study focuses on the golden rule of public finance, which distinguishes public investment from consumption spending when borrowing and permits only debt-financed public investment, in an overlapping-generations model with physical and human capital accumulation. In this model, the rule and the associated fiscal policy are endogenous, chosen in each period by a short-lived government representing existing generations. We calibrate the model to Germany, Japan, and the United Kingdom, where the rule has been in place, and show that Germany follows the rule while Japan and the United Kingdom break it, which is consistent with current literature. Subsequently, we evaluate the government’s choice and the resulting political distortions of physical and human capital accumulation from the perspective of future generations. We compute the optimal proportion of debt-financed public investment in terms of minimizing the political distortions and find that in each country, the optimal proportion is lower than the one determined by the short-lived government.

• Item Type: MPRA Paper
• Language: English
• Keywords: fiscal rule; golden rule of public finance; probabilistic voting; overlapping generations; political distortions
• Subjects: D - Microeconomics > D7 - Analysis of Collective Decision-Making > D70 - General; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy; H - Public Economics > H6 - National Budget, Deficit, and Debt > H63 - Debt ; Debt Management ; Sovereign Debt

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