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Public debt and aggregate risk

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Author Info

  • Audrey Desbonnet

    () (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, University of Vienna - University of Vienna)

  • Sumudu Kankanamge

    () (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)

Abstract

This paper assesses the long-run optimal level of public debt in a framework where aggregate fluctuations are taken into account. Households are subject to both aggregate and idiosyncratic shocks and the market structure prevents them from perfectly insuring against risk. We find that the long-run optimal level of public debt is generally higher in a setting embedding aggregate fluctuations than in a setting without. Aggregate fluctuations modify both the cost and the motive for precautionary saving. Higher levels of public debt, by effectively reducing the cost of precautionary saving, help agents to smooth consumption when they face price and employment fluctuations.

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Bibliographic Info

Paper provided by HAL in its series Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) with number halshs-00175877.

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Date of creation: Aug 2008
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Handle: RePEc:hal:cesptp:halshs-00175877

Note: View the original document on HAL open archive server: http://halshs.archives-ouvertes.fr/halshs-00175877
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Related research

Keywords: Public debt; aggregate risk; precautionary saving; credit constraints.;

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Cited by:
  1. Petia Topalova & Dan Nyberg, 2010. "What Level of Public Debt Could India Target?," IMF Working Papers 10/7, International Monetary Fund.
  2. Zhang, Yuewen, 2010. "Sovereign Risk Management in Recession: The Cases of Sweden and China," MPRA Paper 23364, University Library of Munich, Germany.

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