The Economic Effects of Restrictions on Government Budget Deficits

In overlapping-generations economies with perfect financial markets and lumpsum taxation, restrictions on the government budget deficit do not limit the set of achievable allocations. For economies in which the tax instruments are distortionary and limited in number, this strong form of irrelevance does not hold even if markets are perfect. We propose a weaker (but natural) definition of irrelevance in which only a finite (but arbitrarily large) number of restrictions near the baseline deficit are considered. We show that if the government can use only anonymous consumption taxes, there is weak irrelevance of the deficit restrictions if the number of tax instruments is large relative to the number of policy goals. Journal of Economic Literature Classification Numbers: D51, D91, E32. 2000 Academic Press