A Buffer-Stock Model for the Government: Balancing Stability and Sustainability

Author/Editor:

Jean-Marc Fournier

Publication Date:

July 22, 2019

Electronic Access:

Download PDF. Use the free Adobe Acrobat Reader to view this PDF file

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary:

A fiscal reaction function to debt and the cycle is built on a buffer-stock model for the government. This model inspired by the buffer-stock model of the consumer (Deaton 1991; Carroll 1997) includes a debt limit instead of the Intertemporal Budget Constraint (IBC). The IBC is weak (Bohn, 2007), a debt limit is more realistic as it reflects the risk of losing market access. This risk increases the welfare cost of fiscal stimulus at high debt. As a result, the higher the debt, the less governments should smooth the cycle. A larger reaction of interest rates to debt and higher hysteresis magnify this interaction between the debt level and the appropriate reaction to shocks. With very persistent shocks, the appropriate reaction to negative shocks in highly indebted countries can even be procyclical.

Series:

Working Paper No. 19/159

Subject:

English

Publication Date:

July 22, 2019

ISBN/ISSN:

9781498325066/1018-5941

Stock No:

WPIEA2019159

Price:

$18.00 (Academic Rate:$18.00)

Format:

Paper

Pages:

40

Please address any questions about this title to publications@imf.org