In this dissertation I analyze how population aging and political considerations can affect the conduct of fiscal policy and the management of sovereign debt. In Chapter 1 I focus on the impact of an aging population. In Chapter 2 I consider the effects of political uncertainty. How an aging population will affect fiscal policy and government debt is a key question for today’s policymakers, given the striking demographic projections for many countries. I provide an answer to this question in Chapter 1. I develop a dynamic overlapping generations model in which fiscal policy is determined endogenously by voting and sovereign default is allowed. Contrary to existing results derived under risk-free debt, I show that population aging leads to a decline in government debt. The reason is that the risk of default on sovereign debt increases as the population ages, ceteris paribus. The consequent rise in interest rates reduces the government’s incentive to borrow and ensures that debt remains sustainable, i.e., the probability of observing a default in equilibrium stays low and constant. However, debt sustainability comes at the cost of recurrent tax hikes and severe cuts to entitlements for the elderly. An international lending facility that allows the government to borrow at a low fix rate eventually exacerbates the welfare costs of population aging. In contrast, increasing the minimum retirement age improves the welfare of all future generations. The project I present in Chapter 2, co-authored with Sergio Armella, rationalizes the empirical observation that sovereign debt spreads respond to political uncertainty in a model where creditors learn the hidden propensity to honor debt obligations from government actions over time. We assume alternation in power of two types of government facing different costs of default on debt. Market participants do not know which type they are facing in each period. They form beliefs about it, which are updated according to observed fiscal policy decisions and political transition probabilities. We derive the conditions for the existence of pooling and separating equilibria on default and borrowing choices. As lenders beliefs about facing a government with low default costs strengthen, sovereign spreads increase, causing a contraction in public borrowing and spending. A version of our model calibrated to the Italian economy shows that the asymmetric information amplifies the increase in the level and the volatility of spreads stemming from political turnover, with negative implications for welfare.

Creator

• Magistretti, Giacomo

DOI

• https://doi.org/10.21985/n2-sp10-6009

Subject

• Economics

Language

• en

Alternate Identifier

• etdadmin_upload_743431
• http://dissertations.umi.com/northwestern:15113

Keyword

• Population aging
• Sovereign debt
• Political uncertainty
• Fiscal policy

Date created

• 2020-01-01

Resource type

• Dissertation

Rights statement

• In Copyright