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Why do governments end up with debt ? Short-run effects matter

Author

Listed:
  • Audrey Desbonnet

    (LEDa - Laboratoire d'Economie de Dauphine - IRD - Institut de Recherche pour le Développement - Université Paris Dauphine-PSL - CNRS - Centre National de la Recherche Scientifique)

  • Thomas Weitzenblum

    (EQUIPPE - Economie Quantitative, Intégration, Politiques Publiques et Econométrie - Université de Lille, Droit et Santé - PRES Université Lille Nord de France - Université de Lille, Sciences Humaines et Sociales - Université de Lille, Sciences et Technologies)

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.

Suggested Citation

  • Audrey Desbonnet & Thomas Weitzenblum, 2012. "Why do governments end up with debt ? Short-run effects matter," Post-Print hal-01518357, HAL.
  • Handle: RePEc:hal:journl:hal-01518357
    DOI: 10.1111/j.1465-7295.2011.00410.x
    Note: View the original document on HAL open archive server: https://hal.archives-ouvertes.fr/hal-01518357
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    File URL: https://hal.archives-ouvertes.fr/hal-01518357/document
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    Cited by:

    1. William B. Peterman & Erick Sager, 2018. "Optimal Public Debt with Life Cycle Motives," Finance and Economics Discussion Series 2018-028, Board of Governors of the Federal Reserve System (U.S.), revised 20 Apr 2018.
    2. Chatterjee, Santanu & Gibson, John & Rioja, Felix, 2018. "Public investment, debt, and welfare: A quantitative analysis," Journal of Macroeconomics, Elsevier, vol. 56(C), pages 204-217.
    3. Zuzana Mucka & Ludovit Odor, 2018. "Optimal sovereign debt: Case of Slovakia," Working Papers Working Paper No. 3/2018, Council for Budget Responsibility.

    More about this item

    Keywords

    Government Policy; Public debt;

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