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On the needed quantity of government debt

  • Kathryn Birkeland
  • Edward C. Prescott

People are enjoying longer retirement periods, and population growth is slowing and, in some countries, falling. In this article, we determine the implications of these demographic changes for the needed amount of government debt. If tax rates and the transfer share of gross national income (GNI) are both high, the needed debt is near zero. With such a system, however, huge deadweight losses are incurred as a result of the high tax rate on labor income. With a savings system, a large government debt to annual GNI ratio is needed. In a country with early retirement and no population growth, the needed government debt is as large as five times GNI, and welfare is as much as 24 percent higher in terms of lifetime consumption equivalents in the savings system relative to the tax-and-transfer system.

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Article provided by Federal Reserve Bank of Minneapolis in its journal Quarterly Review.

Volume (Year): (2007)
Issue (Month): Nov ()
Pages: 2-15

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Handle: RePEc:fip:fedmqr:y:2007:i:nov:p:2-15:n:v.31no.1
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  1. Andrew B. Abel & N. Gregory Mankiw & Lawrence H. Summers & Richard J. Zeckhauser, 1986. "Assessing Dynamic Efficiency: Theory and Evidence," NBER Working Papers 2097, National Bureau of Economic Research, Inc.
  2. S. Rao Aiyagari & Ellen R. McGrattan, 1997. "The optimum quantity of debt," Staff Report 203, Federal Reserve Bank of Minneapolis.
  3. Ellen R. McGrattan & Edward C. Prescott, 2003. "Average Debt and Equity Returns: Puzzling?," Levine's Working Paper Archive 506439000000000367, David K. Levine.
  4. Robert W. Fogel, 2005. "Changes in the Physiology of Aging during the Twentieth Century," NBER Working Papers 11233, National Bureau of Economic Research, Inc.
  5. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
  6. Edward C. Prescott, 2006. "Nobel Lecture: The Transformation of Macroeconomic Policy and Research," Journal of Political Economy, University of Chicago Press, vol. 114(2), pages 203-235, April.
  7. Ellen R. McGrattan & Edward C. Prescott, 2001. "Is the Stock Market Overvalued?," NBER Working Papers 8077, National Bureau of Economic Research, Inc.
  8. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
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