Question Debt Sustainability and Fiscal Councils

Q A) Theory: examine the factors that determine the dynamics of the debt-to–GDP ratio and the causes of debt accumulation (Use equations and graphs to answer this question). Discuss the dangers of a very high public debt and the options open to a government to stabilize a high and growing debt ratio.

References: Chapter 21 in Blanchard (Problem with High Debt, lecture slides and tutorial material)

B) Policy: the rapid increase in government debt in most OECD economies in the 1990s lead economists to argue that fiscal policy was subject to a deficit bias and that discretionary policy had to be abandoned in favour of fiscal rules. However, the recent explosion in government debt suggests that the rules approach was not sufficient for stable public finances and the need to search for new ways of ensuring fiscal discipline. An idea that has received widespread attention is the establishment of independent fiscal institutions.

Questions : Define the deficit bias and provide three reasons for its existence. Discuss how fiscal councils can contribute to fiscal discipline by reducing the problem of deficit bias. Discuss why there exists the potential for the UK government to exert some indirect influence on the OBR's forecasts and to undermine its independence.