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Debt stabilization in a Non-Ricardian economy

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  • Campbell Leith
  • Ioana Moldovan
  • Simon Wren-Lewis

Abstract

In models with a representative infinitely lived household, modern versions of tax smoothing imply that the steady-state of government debt should follow a random walk. This is unlikely to be the case in OLG economies, where, the equilibrium interest rate may differ from the policy-maker’s rate of time preference such that it may be optimal to reduce debt today to reduce distortionary taxation in the future. Moreover, the level of the capital stock (and therefore output and, possibly, consumption) in these economies is likely to be sub-optimally low, and reducing government debt will ‘crowd in’ additional capital. Using an elaborate version of the model of perpetual youth developed by Blanchard (1985) and Yaari (1965), we derive the optimal steady state level of government assets. We show how and why this level of government assets falls short of the level of debt that achieves the optimal capital stock and the level that eliminates income taxes.

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Bibliographic Info

Paper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2011_23.

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Date of creation: Oct 2011
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Handle: RePEc:gla:glaewp:2011_23

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Keywords: Non-Ricardian consumers; macroeconomic stability; distortionary taxes;

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References

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  1. Leith, Campbell & Malley, Jim, 2005. "Estimated general equilibrium models for the evaluation of monetary policy in the US and Europe," European Economic Review, Elsevier, vol. 49(8), pages 2137-2159, November.
  2. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October.
  3. Ascari, Guido & Rankin, Neil, 2007. "Perpetual youth and endogenous labor supply: A problem and a possible solution," Journal of Macroeconomics, Elsevier, vol. 29(4), pages 708-723, December.
  4. S. Rao Aiyagari & Albert Marcet & Thomas J. Sargent & Juha Seppala, 2002. "Optimal Taxation without State-Contingent Debt," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1220-1254, December.
  5. Campbell Leith & Simon Wren-Lewis, 2006. "Fiscal Sustainability in a New Keynesian Model," Working Papers 2006_11, Business School - Economics, University of Glasgow, revised Nov 2008.
  6. Campbell Leith & Simon Wren-Lewis, 2010. "Discretionary policy in a monetary union with sovereign debt," Working Papers 2010_23, Business School - Economics, University of Glasgow.
  7. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  8. Calvo, Guillermo A & Obstfeld, Maurice, 1988. "Optimal Time-Consistent Fiscal Policy with Finite Lifetimes," Econometrica, Econometric Society, vol. 56(2), pages 411-32, March.
  9. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  10. Agresti, Anna Maria & Mojon, Benoît, 2001. "Some stylised facts on the euro area business cycle," Working Paper Series 0095, European Central Bank.
  11. Andres Erosa & Martin Gervais, 2001. "Optimal taxation in infinitely-lived agent and overlapping generations models : a review," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 23-44.
  12. Leith, Campbell & Wren-Lewis, Simon, 2000. "Interactions between Monetary and Fiscal Policy Rules," Economic Journal, Royal Economic Society, vol. 110(462), pages C93-108, March.
  13. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. The long run government debt target
    by Mainly Macro in Mainly Macro on 2013-01-11 18:11:00
  2. Optimal Debt Policy for Ireland (Warning: Wonkish)
    by John McHale in The Irish Economy on 2013-02-12 22:22:43

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