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The trade-off between public debt reduction and automatic stabilisation

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  • Hiebert, Paul
  • Pérez, Javier J.
  • Rostagno, Massimo

Abstract

This paper addresses the basic tradeoff between the stabilisation properties of budgets and the sustainability of long run fiscal positions. The modeling framework consists of a simple non-monetary endowment economy with overlapping generations, extended to account for stochastic endowments and borrowing constrained households. A benign government chooses the optimal degree of responsiveness of net taxes to individual incomes and an optimal measure of long-run public debt in order to smooth households' consumption across states of nature. In the presence of a deficit constraint for the government, the results point to the desire for lower debt levels than those currently prevailing in European Union countries in order to enable a more effective hedging of personal income uncertainty by means of more active automatic fiscal stabilisers. The optimal degree of automatic stabilisation and debt reduction is conditional on the characteristics of economic cycles.

Suggested Citation

  • Hiebert, Paul & Pérez, Javier J. & Rostagno, Massimo, 2009. "The trade-off between public debt reduction and automatic stabilisation," Economic Modelling, Elsevier, vol. 26(2), pages 464-472, March.
    • Handle: RePEc:eee:ecmode:v:26:y:2009:i:2:p:464-472
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    4. Javier Andrés & Javier J. Pérez & Juan A. Rojas, 2017. "Implicit public debt thresholds: an empirical exercise for the case of Spain," Working Papers 1701, Banco de España.
    5. Yagihashi, Takeshi, 2011. "Estimating Taylor rules in a credit channel environment," The North American Journal of Economics and Finance, Elsevier, vol. 22(3), pages 344-364.

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