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Title: Persistent Government Debt and Aggregate Risk Distribution

Author(s): Mariano Massimiliano Croce, Thien Nguyen and Steve Raymond

Publication Date: August 2019

Keyword(s): asset prices, Endogenous Growth Risk and Fiscal policy

Programme Area(s): Financial Economics, Macroeconomics and Growth and Public Economics

Abstract: When government debt is sluggish, consumption exhibits lower expected growth, more long-run uncertainty, and more long-run downside risk. Simultaneously, the risk premium on the consumption claim (Koijen et al. (2010), Lustig et al. (2013)) increases and features more positive (adverse) skewness. We rationalize these findings in an endogenous growth model in which fiscal policy is distortionary, the value of innovation depends on fiscal risk, and the representative agent is sensitive to the resulting distribution of consumption risk. Our model suggests that committing to a rapid reduction of the debt-to-output ratio can enhance the value of innovation, aggregate wealth, and welfare.

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Bibliographic Reference

Croce, M, Nguyen, T and Raymond, S. 2019. 'Persistent Government Debt and Aggregate Risk Distribution'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=13922