On the Political Economy of Public Deficits and Debt

Abstract

Abstract In OECD countries, we have observed a considerable increase in public debt over recent decades caused by large and lasting deficits. What is the reason for this development and why is it rather different by country? There are two approaches to explain this. Traditional economic theory explains why it makes sense to allow deficits of public budgets in certain situations, which might result in a limited amount of public debt. It also shows the conditions for the sustainability of public finances namely that public debt stays below certain limits and, in particular, does not - in the long run - increase faster than GDP. Following the recommendations of this approach, public budget surpluses should be run in economic upswings to compensate for deficits in recessions. By contrast, politico-economic approaches explain why democratic governments have incentives to allow deficits even in periods of economic upswings. In the long run, this can lead to ever-increasing public debt. To prevent this, institutional provisions are necessary. In this respect, Swiss debt brakes at the national and cantonal levels as well as the new German rules are of particular interest.