Game Over: Simulating Unsustainable Fiscal Policy

Richard Evans, Laurence Kotlikoff and Kerk L. Phillips

No 17917, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Fiscal sustainability is one of the most pressing policy issues of our time. Yet it remains difficult to quantify. Official debt is plagued with a number of measurement difficulties since its measurement reflects the choice of words, not policies. And forming the fiscal gap-the imbalance in the government's intertemporal budget-requires strong discount rate assumptions. An alternative approach, taken here, is specifying a stochastic general equilibrium model and determining via simulation how long it takes for the economy to reach game over-the point where current policy can no longer be maintained. Our simulations, based on an OLG model calibrated to the U.S. economy, produce an average duration to game over of roughly one century, with a 35 percent chance of reaching the fiscal limit in roughly 30 years. The prospect of man-made economic collapse produces large equity premia, like those observed in the data. Our simulations show that both the fiscal gap and the equity premium rise as the economy gets closer to hitting its fiscal limit, suggesting that the fiscal gap and the equity premium may be good indicators of unsustainable policy.

JEL-codes: C63 C68 E62 H55 (search for similar items in EconPapers)
Date: 2012-03
New Economics Papers: this item is included in nep-cmp and nep-dge
Note: EFG PE
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Citations: View citations in EconPapers (14)

Published as Game Over: Simulating Unsustainable Fiscal Policy , Richard W. Evans, Laurence J. Kotlikoff, Kerk L. Phillips. in Fiscal Policy after the Financial Crisis , Alesina and Giavazzi. 2013

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Chapter: Game Over: Simulating Unsustainable Fiscal Policy (2012)
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