Sticky Spending, Sequestration and Debt

Political and legal costs make it difficult to cut existing spending programs. This renders spending “sticky” which, according to the prevalent view, leads to higher debt accumulation. But, fiscal rules are in place to prevent excessive indebtedness, one important such rule is sequestration: mandatory across the board spending cuts . To assess these arguments, we consider a strategic model of debt with two parties that alternate in power. In line with the common view, we find that budget stickiness directly reinforces the incumbent’s incentive to accumulate debt. Yet, “sticky” budgets together with the possibility of sequestration, generates additional indirect channels with disparate consequences. Since the combination of the two insure politicians against power fluctuations, in some cases more stickiness could lead to less debt, to the point that the over-accumulation problem could be completely eliminated. However, if the initial entitlements are large, the sequestration could be used to dilute them, increasing rather than decreasing debt.