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Is United States Deficit Policy Playing with Fire?

Paper Session

Saturday, Jan. 4, 2020 2:30 PM - 4:30 PM (PST)

Marriott Marquis, Grand Ballroom 3
Hosted By: American Economic Association
  • Chair: Laurence Kotlikoff, Boston University

Public Debt, Low Interest Rates, and Negative Shocks

Richard Evans
University of Chicago


Debt-to-GDP ratios across developed economies are at historically high levels and government borrowing rates have remained persistently low. Blanchard (2019) provides evidence that the fiscal costs are low of increased government debt in low interest rate environments and that long-run average welfare effects can be positive. This paper attempts to replicate Blanchard's main results and tests their robustness to some key assumptions about risk in the model. This study finds that the attempted replication of Blanchard's stated approach results in no long-run average welfare gains from increased government debt and that those welfare losses are exacerbated if some strong risk-reducing assumptions are relaxed to more realistic values. Furthermore, I argue that the Blanchard calibration strategy also biases the results toward more beneficial government debt.

Simulating the Blanchard Conjecture in a Multi-Period Life-Cycle Model

Jasmina Hasanhodzic
Babson College


In recent writings, Olivier Blanchard and Lawrence Summers have suggested that additional deficit-financed U.S. federal spending would come at no cost to any future generation and benefits to some, with welfare measured in terms of expected remaining or entire lifetime utility. This paper studies this question in a ten-period overlapping generations model in which agents face macroeconomic uncertainty about their future earnings and demand government bonds to limit their risk. It shows that the safe rate on government debt can, on average, be far less than the economy’s growth rate without its implying that ongoing redistribution from the young to the old is Pareto improving. Indeed, in a 10-period, OLG, CGE model, whose average safe rate averages negative 2 percent on an annual basis, welfare losses to future generations resulting from the introduction of pay-go Social Security, financed with a 15 percent payroll tax, are enormous – roughly 20 percent measured as a compensating variation relative to no policy.

Leveraging Posterity's Prosperity?

Johannes Brumm
Karlsruhe Institute of Technology
Laurence Kotlikoff
Boston University
Felix Kubler
University of Zurich


We critically review two studies – one by Blanchard (B) and one by Rachel and Summers (RS). By the standard fiscal-gap measure of fiscal solvency, the U.S. government is in dire, long-term fiscal shape. This is thanks to running, for seven decades straight, an ever-expanding, take-as-you-go Ponzi scheme. Yet B and RS entertain expanding the scheme. B’s rationale is achieving a Pareto improvement. RS seek to forestall secular stagnation. Their arguments largely rely on the U.S. growth rate exceeding the supposed marginal safe borrowing rate – the rate on short U.S. bonds. But almost all households face far higher marginal rates, namely the rates they can earn by pre-paying their high-interest mortgages, car, student, and other loans. We also question certain B and RS modeling assumptions that presage key results and caution that one can easily construct very low, safe-rate models, which, nonetheless, do not admit beneficial Ponzi schemes.
Alan Auerbach
University of California-Berkeley
Seth Benzell
Massachusetts Institute of Technology
JEL Classifications
  • H6 - National Budget, Deficit, and Debt