Government policy with time inconsistent voters

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Abstract

Behavioral economics presents a "paternalistic" rationale for benevolent government intervention. This paper presents a model of public debt where voters have self-control problems and attempt to commit using illiquid assets. In equilibrium, government accumulates debt to respond to individuals' desire to undo their commitments, which leads individuals to rebalance their portfolio, in turn feeding into a demand for further debt accumulation. As a consequence, (i) large (and distortionary) government debt accumulation occurs, and (ii) banning illiquid assets could improve individuals' welfare. These results offer a new rationale for balanced budget rules in constitutions to restrain governments' responses to voters' self-control problems.

Original languageEnglish (US)
Pages (from-to)1711-1737
Number of pages27
JournalAmerican Economic Review
Volume105
Issue number6
DOIs
StatePublished - Jun 1 2015
Externally publishedYes

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

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