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Why Do Governments End Up With Debt? Short-Run Effects Matter

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  • AUDREY DESBONNET
  • THOMAS WEITZENBLUM

Abstract

This paper reconsiders the impact of public debt in an economy with heterogeneous households and incomplete markets to emphasize the short-run effects of an increase in public debt. As compared to models that rest on steady-state analysis, we show that the welfare gains of a public debt increase are substantially higher when transitional dynamics are accounted for. The additional debt issue allows for a temporary reduction in the income tax rate, which stimulates labor supply and generates an overshooting of the interest rate. The short-run gains create a temptation to deviate toward higher levels of debt. Debt increases continue to generate welfare gains even when debt is considerably higher than its long-run optimal level.
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Suggested Citation

  • Audrey Desbonnet & Thomas Weitzenblum, 2012. "Why Do Governments End Up With Debt? Short-Run Effects Matter," Economic Inquiry, Western Economic Association International, vol. 50(4), pages 905-919, October.
  • Handle: RePEc:bla:ecinqu:v:50:y:2012:i:4:p:905-919
    DOI: j.1465-7295.2011.00410.x
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    File URL: http://hdl.handle.net/10.1111/j.1465-7295.2011.00410.x
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    Cited by:

    1. Dieppe, Alistair & Mourinho Félix, Ricardo & Marchiori, Luca & Grech, Owen & Albani, Maria & Kulikov, Dmitry & Papadopoulou, Niki & Sideris, Dimitris & Irac, Delphine & Gordo Mora, Esther & Vogel, Edg, 2015. "Public debt, population ageing and medium-term growth," Occasional Paper Series 165, European Central Bank.
    2. repec:cup:macdyn:v:21:y:2017:i:08:p:1996-2032_00 is not listed on IDEAS
    3. Röhrs, Sigrid & Winter, Christoph, 2015. "Public versus private provision of liquidity: Is there a trade-off?," Journal of Economic Dynamics and Control, Elsevier, vol. 53(C), pages 314-339.
    4. Desbonnet, Audrey & Kankanamge, Sumudu, 2017. "Public Debt And Aggregate Risk," Macroeconomic Dynamics, Cambridge University Press, vol. 21(08), pages 1996-2032, December.
    5. Vogel, Edgar, 2014. "Optimal level of government debt - matching wealth inequality and the fiscal sector," Working Paper Series 1665, European Central Bank.
    6. Röhrs, Sigrid & Winter, Christoph, 2017. "Reducing government debt in the presence of inequality," Journal of Economic Dynamics and Control, Elsevier, vol. 82(C), pages 1-20.
    7. repec:ecb:ecbops:2014165 is not listed on IDEAS
    8. repec:eee:dyncon:v:83:y:2017:i:c:p:162-174 is not listed on IDEAS
    9. Vogel, Edgar, 2014. "Optimal Level of Government Debt: Matching Wealth Inequality and the Fiscal Sector," MEA discussion paper series 201410, Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy.

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