Public debt and time preferences: Insolvency, excessive saving and in between

Democracy tends to cultivate short-sighted politicians, for whom the horizon extends more or less till next election. This feature gives rise to a discrepancy between the time rate of discount of a country’s polity and the interest rates at which the country borrows. I show how this discrepancy induces public debt swelling. Moreover, if the discrepancy exceeds a certain threshold, public debt will accumulate to the point of insolvency and, to make matter worse, this (unfortunate) state of affairs will be approached at a finite time. Conversely, if budget decision makers are so far-sighted that their time rate of discount is smaller than the relevant interest rate, the country becomes an excessive saver. If the polity’s time rate of discount falls neither below the market interest rate nor exceeds it too much, equilibrium will be reached at a debt-to-GDP ratio between insolvency and excessive saving. Economic growth exacerbates the debt accumulation problem, making insolvency more likely compared to a ceteris-paribus stationary economy.


Issue Date:
Sep 12 2012
Publication Type:
Working or Discussion Paper
PURL Identifier:
http://purl.umn.edu/137712
Total Pages:
40
JEL Codes:
C61; H61; H63




 Record created 2017-04-01, last modified 2017-08-26

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