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Is Public Debt Growth-Enhancing or Growth-Reducing?

  • Real Arai

    (Graduate School of Social Sciences, Hiroshima University)

  • Takuma Kunieda

    (Department of Economics and Finance,City University of Hong Kong)

  • Keigo Nishida

    (Faculty of Economics, Fukuoka University)

To understand mixed evidence provided by empirical studies for the relationship between the accumulation of public debt and economic growth, it is necessary to consider not only the crowd-out effect of public debt on economic growth but also the growth-enhancing crowd-in effect that cannot be uncovered by the traditional theoretical achievements. We develop a dynamic general equilibrium model with infinitely lived agents and derive an inverted U-shaped relationship between the accumulation of public debt and economic growth. The analysis focuses on both crowd-out and crowd-in effects that public debt has on private investment in a financially constrained economy and clarifies the mechanism inducing the inverted U-shaped relationship in the growth process. When the public debt-to-GDP ratio is below a certain threshold level, the crowd-in effect dominates the crowd-out effect and the accumulation of public debt promotes economic growth. When the public debt-to-GDP ratio exceeds the threshold level, the accumulation of public debt begins to hinder economic growth with the crowd-out effect dominating the crowd-in effect.

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File URL: http://www.kier.kyoto-u.ac.jp/DP/DP884.pdf
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Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 884.

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Length: 31pages
Date of creation: Jan 2014
Date of revision:
Handle: RePEc:kyo:wpaper:884
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