DP7941 Quantifying the Distortionary Fiscal Cost of ?The Bailout?

Author(s): Francisco J Gomes, Alexander Michaelides, Valery Polkovnichenko
Publication Date: August 2010
Keyword(s): Bailout, Fiscal Policy, Government Debt, Incomplete Financial Markets., Tax Distortions
JEL(s): E21, E62, G12
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7941

We utilize an overlapping generations model with endogenous production and incomplete markets to quantify the distortionary costs associated with financing the increase in government expenditures directed to investments in the private sector in 2008 and 2009 (a.k.a. ?the bailout?), and its differential impact on different groups of the population (in the U.S.A.). In our baseline calibration, this distortion corresponds to a loss of approximately $300 billion dollars in total household consumption. For plausible alternative assumptions regarding both the expected and actual duration of this increase in expenditures, or the willingness of foreign institutions and/or investors in absorbing additional government debt, this number can increase to $800 billion. We find that the cost falls more dramatically on those households which are either older and/or wealthier. Retirees face approximately 50% of the cost, as younger agents are more likely to still be alive when the economy has returned to its steady-state. Across wealth groups, the top 25% of the wealth distribution bears almost two thirds of the cost.