Running Primary Deficits Forever in a Dynamically Efficient Economy: Feasibility and Optimality

Government debt can be rolled over forever without primary surpluses in some stochastic economies, including some economies that are dynamically efficient. In an overlapping‐generations model with constant growth rate, g, of labor‐augmenting productivity, and with shocks to the durability of capital, we show that along a balanced growth path, the maximum sustainable ratio of bonds to capital is attained when the risk‐free interest rate, rf, equals g. Furthermore, this maximal ratio maximizes utility per capita along a balanced growth path and ensures that the economy is dynamically efficient.