Politics and Efficiency of Separating Capital and Ordinary Government Budgets

Marco Bassetto, Federal Reserve Bank of Chicago
Thomas J. Sargent, New York University

Abstract

We analyze a `golden rule' that separates capital and ordinary account budgets and allows a government to finance only capital items with debt. Many national governments followed this rule in the 18th and 19th centuries and most U.S. states do today. We study an overlapping-generations economy where majorities choose durable and nondurable public goods in each period. When demographics imply even moderate departures from Ricardian equivalence, the golden rule substantially improves efficiency. Examples calibrated to U.S. demographics show greater improvements at the state level or with 19th century demographics than under current national demographics.

Older versions available as NBER Working Paper #11030 (2005) and Federal Reserve Bank of Chicago Working Paper 2005-07.