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Given the large deficits in many OECD countries in recent years, and the resulting sharp rise in the public debt, it is important to determine the economic and political forces leading to such large deficits. We lind only partial support for the ‘equilibrium approach to liscal policy’, which assumes that tax rates are set over time in order to minimize the excess burden of taxation. We suggest hat in several countries the slow rate at which the post-‘73 fiscal deficits were reduced resulted from the difliculties of political management in coalition governments. There is a clear tendency for larger deficits in countries characterized by a short average tenure of government and by the presence of many political parties in a ruling coalition. I.

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To recover a version of Barro's (1979) `random walk' tax smoothing outcome, we modify Lucas and Stokey's (1983) economy to permit only risk-free debt. This imparts near unit root like behavior to government debt, independently of the government expenditure process, a realistic outcome in the spirit of Barro's. We show how the risk-free-debtonly economy confronts the Ramsey planner with additional constraints on equilibrium allocations that take the form of a sequence of measurability conditions. We solve the Ramsey problem by formulating it in terms of a Lagrangian, and applying a Parameterized Expectations Algorithm to the associated first-order conditions. The first-order conditions and numerical impulse response functions partially affirm Barro's random walk outcome. Though the behaviors of tax rates, government surpluses, and government debts differ, allocations are very close for computed Ramsey policies across incomplete and complete markets economies.

The authors have benefitted from discussions with Rao Aiyagari as well as from seminars at Harvard and Indiana Universities. The views expressed in this paper are those of the authors and do not necessarily represent the views of the Board of Governors of the Federal Reserve System. Financial support from the Alfred P. Sloan Foundation is gratefully acknowledged. The research reported here is part of the NBER's research program-in Economic Fluctuations. Any opinions expressed are those of the authors and not those of the

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For U.S. annual data that include WWII, the estimated multiplier for defense spending is 0.6-0.7 at the median unemployment rate. There is some evidence that this multiplier rises with the extent of economic slack and reaches 1.0 when the unemployment rate is around 12%. Multipliers for non-defense purchases cannot be reliably estimated from U.S. macroeconomic time series because of the lack of good instruments. Since the defense-spending multiplier is typically less than one, greater spending tends to crowd out other components of GDP. The largest effects are on private investment, but non-defense purchases and net exports tend also to fall. The response of private consumer expenditure differs insignificantly from zero. For samples that begin in 1950, increases in average marginal income-tax rates (measured by a newly constructed time series) have a significantly negative effect on real GDP. We lack reliable statistical evidence on how this response divides up between substitution effects from changes in tax rates versus income effects from changes in government revenue.

We study economic growth and inflation at different levels of government and external debt. Our analysis is based on new data on forty-four countries spanning about two hundred years. The dataset incorporates over 3,700 annual observations covering a wide range of political systems, institutions, exchange rate arrangements, and historic circumstances. Our main findings are: First, the relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more. We find that the threshold for public debt is similar in advanced and emerging economies. Second, emerging markets face lower thresholds for external debt (public and private)—which is usually denominated in a foreign currency. When external debt reaches 60 percent of GDP, annual growth declines by about two percent; for higher levels, growth rates are roughly cut in half. Third, there is no apparent contemporaneous link between inflation and public debt levels for the advanced countries as a group (some countries, such as the United States, have experienced higher inflation when debt/GDP is high.) The story is entirely different for emerging markets, where inflation rises sharply as debt increases.

H ow does the source of political leadership affect public policy? Is thepublic sector run differently when its leaders are elected “fairly”? How,exactly? These questions are important. Nondemocracies are prevalent around the world. According to data from the POLITY IV (2000) project, which provides a widely used dataset on the authority characteristics of modern polities over the last two centuries, nondemocratic regimes ruled the majority of countries, and the majority of the world’s population, until 1991. Even since 1991, more than 40 percent of countries and people were ruled by nondemocratic regimes. Political economy theory devoted to the modeling of democratic institutions might there-fore miss much of the world’s public sector activity. A comparison of democracies and nondemocracies may also enhance the understanding of democratic institutions by providing an empirical test of some important implications of formal voting models. We begin this paper by contrasting two schools of thought about determinants of policy: one that emphasizes the role of voting mechanisms in determining policy and a second that argues that democ-racy and other political mechanisms will be (at most) second-order determinants of policy choices once economic and demographic variables are taken into account.

We consider a general class of nonlinear optimal policy problems involving forward-looking constraints (such as the Euler equations that are typically present as structural equations in DSGE models), and show that it is possible, under regularity conditions that are straightforward to check, to derive a problem with linear constraints and a quadratic objective that approximates the exact problem. The LQ approximate problem is computationally simple to solve, even in the case of moderately large state spaces and flexibly parameterized disturbance processes, and its solution represents a local linear approximation to the optimal policy for the exact model in the case that stochastic disturbances are small enough. We derive the second-order conditions that must be satisfied in order for the LQ problem to have a solution, and show that these are stronger, in general, than those required for LQ problems without forward-looking constraints. We also show how the same linear approximations to the model structural equations and quadratic approximation to the exact welfare measure can be used to correctly rank alternative simple policy rules, again in the case of small enough shocks.