Discussion paper
DP13922 Persistent Government Debt and Aggregate Risk Distribution
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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