The Political Economy of Fiscal Policy Public Deficits, Volatility,
One of the most striking macroeconomic developments during the last three decades is the rise and persistence of large fiscal deficits in a number of countries. Despite recent major fiscal reforms around the world, many countries suffer from recurrent lar
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,661 ,6%1 6SULQJHU%HUOLQ+HLGHOEHUJ1HZ 0. Being small, each member of group i takes gi as given and has the same preference for the two public goods within the group. But these two groups differ in their preferences for the public goods, which is reflected by Aj. We assume that 0 < Aj < 1, for i = l , 2 and A2 < | < Ai. This implies that group 1 prefers gi to ^2 and group 2 prefers p2 to pi. Even though the agent in group i may not like the public good gj, j ^ i as much as gi, it is included in her utility function because of non-exclusiveness of public goods. We also assume that she derives positive utility from the consumption of public good which is not her most favorite one.^ We define ^ = Ai — A2 and interpret it as the degree of difference in their preferences for two public goods. We can think of Ö as a degree of polarization between the two groups. We note that 0 < ^ < 1. While 9 = 1 implies the complete disagreement on the composition of two public goods between two groups, 0 = 0 implies the total agreement in their preferences. We will see the important role played by 6 in the evolution of fiscal deficit and fiscal volatility. Also, capital accumulation and growth process depend crucially on 0, as we will show later. In the economy there are two kinds of real assets: capital, denoted by k, and government bonds, denoted by b. The bonds are assumed to be a perfect substitute for capital and therefore to pay the same rate of interest, r. The dynamic budget constraint of the representative agent in group i is then for Vt > 0 and ao > 0 given, äit = rau - Cit - n,
(2.2)
where an is the asset held by an agent and hence an = ku + ba^ and TI is a lump-sum tax collected by the government from group i.^ We also impose the No-Ponzi-Game (NPG) condition: lim ttite"^* > 0.
(2.3)
As long as marginal utility is positive, the agent will not want to have increasing wealth forever at the rate of r, and that condition will hold as an equality. (See Barro and Sala-i-Martin 1995.) The representative agent in group i maximizes the lifetime utility function (2.1) with respect to c^, subject to equations (2.2) and (2.3). It follows from the first-order conditions for this maximization problem that we get ^ For example, even though an agent may care about the public education expenditures
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