Public debt and aggregate risk
AbstractThis 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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Date of creation: Aug 2008
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Public debt; aggregate risk; precautionary saving; credit constraints.;
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- Zhang, Yuewen, 2010. "Sovereign Risk Management in Recession: The Cases of Sweden and China," MPRA Paper 23364, University Library of Munich, Germany.
- Petia Topalova & Dan Nyberg, 2010. "What Level of Public Debt Could India Target?," IMF Working Papers 10/7, International Monetary Fund.
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