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The optimum quantity of debt

Author

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  • S. Rao Aiyagari
  • Ellen R. McGrattan

Abstract

We find that the welfare gains to being at the optimum quantity of debt rather than the current U.S. level are small, and, therefore, concerns regarding the high level of debt in the U.S. economy may be misplaced. This finding is based on a model of a large number of infinitely-lived households whose saving behavior is influenced by precautionary saving motives and borrowing constraints. This model incorporates a different role for government debt than is found in standard models, and it captures different cost-benefit trade-offs. On the benefit side, government debt enhances the liquidity of households by providing an additional means of smoothing consumption and by effectively loosening borrowing constraints. On the cost side, the implied taxes have adverse wealth distribution and incentive effects. In addition, government debt crowds out capital via higher interest rates and lowers per capita consumption.

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  • S. Rao Aiyagari & Ellen R. McGrattan, . "The optimum quantity of debt," Staff Report, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmsr:203
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    References listed on IDEAS

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    Cited by:

    1. Marvin Goodfriend, 2005. "Narrow money, broad money, and the transmission of monetary policy," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 276-303.
    2. James B. Bullard & Steven Russell, 1998. "Monetary steady states in a low real interest rate economy," Working Papers 1994-012, Federal Reserve Bank of St. Louis.
    3. Gale, William G., 2019. "Fiscal policy with high debt and low interest rates," MPRA Paper 99207, University Library of Munich, Germany.
    4. Coelho, José, 2020. "Universal basic income and skill-biased technological change," MPRA Paper 99195, University Library of Munich, Germany, revised 20 Mar 2020.

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