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How Budget Deficit Impairs Long-Term Growth and Welfare under Perfect Capital Mobility

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  • Michał Konopczyński

    (Poznań University of Economics)

Abstract

This paper investigates the implications of the size of budget deficit in the open economy under perfect mobility of capital. For that purpose we construct a general equilibrium model with consumers maximizing the discounted utility of consumption, and firms maximizing profits. Government sets the size of the deficit relative to GDP and controls the structure of public debt. Using standard methods of optimal control theory we solve the model, i.e. we find explicit formulas for all trajectories and the level of welfare. Finally, we show that the higher the deficit-to-GDP ratio, the lower the welfare of consumers. Similarly, welfare increases with the share of foreign creditors in public debt.

Suggested Citation

  • Michał Konopczyński, 2014. "How Budget Deficit Impairs Long-Term Growth and Welfare under Perfect Capital Mobility," Central European Journal of Economic Modelling and Econometrics, Central European Journal of Economic Modelling and Econometrics, vol. 6(3), pages 129-152, September.
    • Handle: RePEc:psc:journl:v:6:y:2014:i:3:p:129-152
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    References listed on IDEAS

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    More about this item

    Keywords

    budget deficit; optimal fiscal policy; perfect capital mobility;
    All these keywords.

    JEL classification:

    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents
    • H60 - Public Economics - - National Budget, Deficit, and Debt - - - General

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