Growth and fiscal policy: a positive theory

Abstract

We present a political economy theory of growth in which the government affects the growth rate both directly through public investments in infrastructure, and indirectly through the effect of taxation on learning by doing. Policy choices are made by a legislature consisting of representatives elected by geographicallydefined districts. The legislature can raise revenues via a discretionary income tax and by issuing public debt. We study the equilibrium relationship between the dynamics of debt and the growth rate of the economy. We use the model to study the impact of an “austerity program” in which a country is forced to reduce the debt/GDP ratio. To quantify these effects, the model is calibrated to the U.S. economy.