DP13922 Persistent Government Debt and Aggregate Risk Distribution

Author(s): Mariano Massimiliano Croce, Thien Nguyen, Steve Raymond
Publication Date: August 2019
Keyword(s): asset prices, Endogenous Growth Risk, Fiscal policy
JEL(s): E62, G1, H2, H3
Programme Areas: Public Economics, Financial Economics, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13922

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.