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The maximum debt-GDP ratio and endogenous growth in the Diamond overlapping generations model: Three overlapping generations are better than two

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  • Mark Roberts
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    Abstract

    While the public debt has an interior maximum in the Diamond OLG model, due to an inherent nonlinearity [Rankin and Roffia (2003)], this feature also extends to a linear, AK model when it is conjoined with a backward-looking adjustment process for public debt [Braeuninger (2005)]. We show that if the debt dynamics are forward-looking, the maximum will instead be at a degeneracy – another possibility considered by Rankin and Roffia. However, the main point of the present paper is to show that any debt maximum in a finite-horizon model will be of an implausibly low order of magnitude, unless households save over at least two periods. This is because it is the debt flow that crowds-out investment flows, while this is synonymous with the debt stock in a model with only two, non-altruistic, overlapping generations, thus leading to a low maximum stock by default. Removing this restriction produces plausible results, and causes a low rate of economic growth to be a cause as well as a consequence of a high public debt.

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    Bibliographic Info

    Paper provided by University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM) in its series Discussion Papers with number 2013/01.

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    Date of creation: 2014
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    Handle: RePEc:not:notcfc:14/01

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    Keywords: Public debt; endogenous growth; primary deficit/surplus; dynamics; bifurcation; degeneracy; backward-looking; forward-looking;

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    1. Bohn, H., 1990. "The Sutainability Of Budget Deficits In A Stochastic Economy," Weiss Center Working Papers, Wharton School - Weiss Center for International Financial Research 6-90, Wharton School - Weiss Center for International Financial Research.
    2. Mark A Roberts, 2013. "Fiscal rules and the maximum sustainable size of the public debt in the Diamond overlapping generations model," Discussion Papers 2013/07, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
    3. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
    4. Romer, Paul M, 1986. "Increasing Returns and Long-run Growth," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 94(5), pages 1002-37, October.
    5. Chalk, Nigel A., 2000. "The sustainability of bond-financed deficits: An overlapping generations approach," Journal of Monetary Economics, Elsevier, vol. 45(2), pages 293-328, April.
    6. Alfred Greiner & Uwe Köller & Willi Semmler, 2007. "Debt sustainability in the European Monetary Union: Theory and empirical evidence for selected countries," Oxford Economic Papers, Oxford University Press, vol. 59(2), pages 194-218, April.
    7. Mark Roberts, 2014. "A non-monotonic relationship between public debt and economic growth: the effect of financial monopsony," Discussion Papers 2014/03, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
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