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Public debt in calibrated OLG models: Fiscal arithmetic versus welfare analysis

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  • Brumm, Johannes
  • Hußmann, Jakob

Abstract

We analyze the fiscal and welfare implications of the size of public debt in stochastic OLG models with distortionary taxation. The government borrowing rate is realistically sensitive to debt issuance and lower than the growth rate. The risky rate is much higher due to convenience benefits of public debt, idiosyncratic return risk, and aggregate risk. Although free-lunch deficits can reduce tax distortions, welfare-maximizing debt (WMD) is considerably lower than deficit-maximizing debt (DMD) in our baseline model calibrated to the US economy. A detailed decomposition of ex ante welfare reveals the forces shaping WMD, the strongest being the positive risk-sharing effect and the negative crowding-out effect. We identify key drivers, such as pension policy or risk premia, and quantify their differential impact on WMD and DMD. Extending the model to account for market power substantially reduces WMD. When wealth inequality is included in the model, the rich favor much higher debt than the middle class.

Suggested Citation

  • Brumm, Johannes & Hußmann, Jakob, 2026. "Public debt in calibrated OLG models: Fiscal arithmetic versus welfare analysis," Journal of Monetary Economics, Elsevier, vol. 162(C).
    • Handle: RePEc:eee:moneco:v:162:y:2026:i:c:s0304393226000899
    DOI: 10.1016/j.jmoneco.2026.103974
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    Keywords

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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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