Government Policy with Time Inconsistent Voters
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.
© 2015 American Economic Association. We thank Daron Acemoglu, Guido Lorenzoni, Wolfgang Pesendorfer, Nikita Roketskiy, Bernardo Silveira, and Michael Ting for very helpful discussions and feedback. We gratefully acknowledge financial support from the National Science Foundation and the Gordon and Betty Moore Foundation (through grant 1158). Bisin wishes to acknowledge the support of the Ministry of Education and Science of the Russian Federation, grant 14.U04.31.0002, administered through the NES CSDSI.
Supplemental Material - 20131306_app.pdf
Supplemental Material - 20131306_ds.zip
Published - aer.20131306.pdf