The Political Economy of Public Debt: A Laboratory Study

59 Pages Posted: 6 Aug 2018

See all articles by Marco Battaglini

Marco Battaglini

Cornell University

Salvatore Nunnari

Bocconi University; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research

Thomas R. Palfrey

California Institute of Technology - Division of the Humanities and Social Sciences

Multiple version iconThere are 3 versions of this paper

Date Written: August 2018

Abstract

This paper reports the results from a laboratory experiment designed to study political distortions in the accumulation of public debt. A legislature bargains over the levels of a public good and of district specific transfers in two periods. The legislature can issue or purchase risk-free bonds in the first period and the level of public debt creates a dynamic linkage across policymaking periods. In line with the theoretical predictions, we find that public policies are inefficient and efficiency is increasing in the size of the majority requirement, with higher investment in public goods and lower debt associated with larger majority requirements. Debt is lower when the probability of a negative shock to the economy in the second period is higher indicating that even in a political equilibrium debt is used to smooth consumption and to insure against political uncertainty. Finally, also in line with the theoretical predictions, we find that dynamic distortions are eliminated independently of the voting rule when the first period majority can commit to a policy for the second period. The experiment however highlights two phenomena that are surprising in terms of standard theory and have not been previously documented. First, balancing the budget in each period is a focal point, leading to lower distortions than predicted. Second, higher majority requirements induce significant delays in reaching an agreement.

Keywords: Bargaining, Dynamic Political Economy, Laboratory experiments, public debt

JEL Classification: C78, C92, D71, D72, H41, H54

Suggested Citation

Battaglini, Marco and Nunnari, Salvatore and Palfrey, Thomas R., The Political Economy of Public Debt: A Laboratory Study (August 2018). CEPR Discussion Paper No. DP13097, Available at SSRN: https://ssrn.com/abstract=3226872

Marco Battaglini (Contact Author)

Cornell University ( email )

Ithaca, NY 14853
United States

Salvatore Nunnari

Bocconi University

Via Sarfatti, 25
Milan, MI 20136
Italy

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research

Via Roentgen 1
Milan, 20136
Italy

Thomas R. Palfrey

California Institute of Technology - Division of the Humanities and Social Sciences ( email )

1200 East California Blvd.
301A Baxter Hall
Pasadena, CA 91125
United States
626-395-4088 (Phone)
626-4432-1726 (Fax)

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