Inequality and Public Debt: A Positive Analysis

This study extends the multi-country, politico-economic model of fiscal policy developed by Song, Storesletten, and Zilibotti (2012) to incorporate wage inequality within each country. In this extended framework, we present conflict within and across generations over fiscal policy and show that a low-inequality country realizes tight fiscal policy with low public debt accumulation, whereas a high-inequality country experiences loose fiscal policy with high public debt accumulation. This model prediction is consistent with empirical evidence from OECD countries for the past three decades.