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Debt Limits And Endogenous Growth

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  • Beatriz de-Blas-Perez

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Abstract

This paper studies the consequences on growth and welfare of imposing limits to public borrowing. In the model economy, government spending may play two different roles, either as input in the production function, or providing services directly in the utility function. In these setups I study the effects of different fiscal policies with and without debt limits both in the balanced growth path and during the transitional dynamics. In the long run, if there is no limit, the growth effects of raising labor income taxes are negative, regardless of the role of government spending. However, the role public spending is crucial for the growth effects of changes in the ratio of public expenditures to output. In the presence of a limit to debt, higher labor tax rates have a positive effect on growth if government spending is productive. The opposite is true when private capital drives growth. Regarding welfare, raising labor income taxes imply a lower welfare cost of reducing debt than does cutting government spending, when this is productive.

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Paper provided by Universidad Carlos III, Departamento de Economía in its series Economics Working Papers with number we052717.

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Date of creation: Apr 2005
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Handle: RePEc:cte:werepe:we052717

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  1. Nancy L. Stokey & Sergio Rebelo, 1993. "Growth Effects of Flat-Rate Taxes," NBER Working Papers 4426, National Bureau of Economic Research, Inc.
  2. Romer, Paul M, 1986. "Increasing Returns and Long-run Growth," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 1002-37, October.
  3. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  4. Glomm, Gerhard & Ravikumar, B., 1994. "Public investment in infrastructure in a simple growth model," Journal of Economic Dynamics and Control, Elsevier, vol. 18(6), pages 1173-1187, November.
  5. V. V. Chari & Patrick J. Kehoe, 1998. "On the need for fiscal constraints in a monetary union," Working Papers 589, Federal Reserve Bank of Minneapolis.
  6. Lucas, Robert E, Jr, 1990. "Supply-Side Economics: An Analytical Review," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 293-316, April.
  7. Sergio Rebelo, 1999. "Long Run Policy Analysis and Long Run Growth," Levine's Working Paper Archive 2114, David K. Levine.
  8. Merih Uctum & Michael Wickens, 1996. "Debt and deficit ceilings, and sustainability of fiscal policies: an intertemporal analysis," Research Paper 9615, Federal Reserve Bank of New York.
  9. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : II. New directions," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 309-341.
  10. Barro, Robert J, 1990. "Government Spending in a Simple Model of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages S103-26, October.
  11. Bayoumi, Tamim & Goldstein, Morris & Woglom, Geoffrey, 1995. "Do Credit Markets Discipline Sovereign Borrowers? Evidence from US States," CEPR Discussion Papers 1088, C.E.P.R. Discussion Papers.
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