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Abstract

Democracy restricts the tenure of influential policymakers, rendering political time horizons shorter than those of ordinary market participants. This feature gives rise to a discrepancy between the government’s time rate of discount and the market interest rate, inducing budget a deficit bias. Governments for which this discrepancy exceeds a certain cut-off level will drive their economies to insolvency. The presence of risk premium mitigates the insolvency prospects by increasing the range of government’s discount rates at which the economy remains solvent, while economic growth exacerbates insolvency prospects by decreasing this range.

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