'Unfunded Liabilities' and Uncertain Fiscal Financing

46 Pages Posted: 13 Mar 2010

See all articles by Eric M. Leeper

Eric M. Leeper

University of Virginia ; Indiana University at Bloomington - Department of Economics; National Bureau of Economic Research (NBER); George Mason University - Mercatus Center

Todd B. Walker

Indiana University Bloomington - Department of Economics

Troy Davig

Federal Reserve Bank of Kansas City

Multiple version iconThere are 2 versions of this paper

Date Written: March 2010

Abstract

A rational expectations framework is developed to study the consequences of alternative means to resolve the "unfunded liabilities" problem - unsustainable exponential growth in federal Social Security, Medicare, and Medicaid spending with no plan to finance it. Resolution requires specifying a probability distribution for how and when monetary and fiscal policies will change as the economy evolves through the 21st century. Beliefs based on that distribution determine the existence of and the nature of equilibrium. We consider policies that in expectation combine reaching a fiscal limit, some distorting taxation, modest inflation, and some reneging on the government's promised transfers. In the equilibrium, inflation-targeting monetary policy cannot successfully anchor expected inflation. Expectational effects are always present, but need not have large impacts on inflation and interest rates in the short and medium runs.

Keywords: Fiscal sustainability, Inflation, Fiscal limit

JEL Classification: H60, E30, E62, H30

Suggested Citation

Leeper, Eric Michael and Walker, Todd B. and Davig, Troy, 'Unfunded Liabilities' and Uncertain Fiscal Financing (March 2010). Available at SSRN: https://ssrn.com/abstract=1568955 or http://dx.doi.org/10.2139/ssrn.1568955

Eric Michael Leeper

University of Virginia ( email )

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National Bureau of Economic Research (NBER)

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George Mason University - Mercatus Center ( email )

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Todd B. Walker

Indiana University Bloomington - Department of Economics ( email )

Wylie Hall
Bloomington, IN 47405-6620
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Troy Davig (Contact Author)

Federal Reserve Bank of Kansas City ( email )

1 Memorial Dr.
Kansas City, MO 64198
United States

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