Fiscal Stagnation

• Authors: Martin Wolf and Luca Fornaro.
• BSE Working Paper: 1488 | April 25
• Keywords: investment , fiscal policy , public policy , Endogenous Productivity Growth , Stagnation
• JEL codes: E22, E62, H63, O40
• investment
• fiscal policy
• public policy
• Endogenous Productivity Growth
• Stagnation

We study public debt sustainability in an economy with endogenous productivity growth. Our model has two key features: i) financing large primary surpluses entails fiscal distortions that depress investment and growth, ii) low growth increases the primary surpluses needed to stabilize the public debt-to-GDP ratio. Negative shocks to fundamentals or pessimistic animal spirits may drive the economy into a state of fiscal stagnation, characterized by high public debt, large fiscal distortions and low productivity growth. We discuss policy options to avoid/escape fiscal stagnation.