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The economic effects of restrictions on government budget deficits

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In overlapping-generations economies with perfect financial markets and lumpsumtaxation, restrictions on the government budget deficits do not limit theset of achievable allocations. For economies in which tax instruments are distortionaryand limited in number, deficits are irrelevant only in the unrealisticcase in which the number of tax instruments is large relative to the numberof policy goals. In particular, if the government can use only anonymous consumptiontaxes, then achieving the prescribed deficits without changing theequilibrium allocation will typically be impossible when the number of consumersexceeds the number of commodities. A similar result holds if consumercredit is (exogenously) restricted. Surprisingly, in this case, distortionary taxesmay be more likely than lump-sum taxes to lead to the irrelevance of governmentdeficits. Journal of Economic Literature Classification Numbers: D51,D91, E32.Keywords: Balanced Budget, Balanced-Budget Amendment, Burden of the Public Debt,Comparative Statics, Consumption Taxes, Credit Restrictions, Distortionary Taxes, EconomicPolicy, Government Budget Deficit, Maastricht Treaty, Optimal Taxation, OverlappingGenerations.

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Christian Ghiglino, Karl Shell

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