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Fiscal rules and the maximum sustainable size of the public debt in the Diamond overlapping generations model

  • Mark A Roberts
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    We show that the size of the maximum sustainable public debt in the Diamond (1965) OLG model depends on the choice of fiscal instrument. If tax revenue is exogenous, there is a maximum at an interior or bifurcation point, as in Rankin and Roffia’s (2003) initial paper but at a generally higher level than for their case of an exogenous debt. Conversely, if income tax rates are exogenous, the technical maximum is at a corner-point of degeneracy, provided the first Inada condition holds. However, as this implies notional average taxes of 100%, a Laffer Curve becomes important, giving rise to another concept of the maximum debt. More generally, for this closed economy case, the form of the production function in conjunction with the fiscal rule will determine whether the maximum debt is reached at a technical point of bifurcation or at a more behavioural one where tax payers en masse deny further payments to bond holders.

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    File URL: http://www.nottingham.ac.uk/cfcm/documents/papers/13-07.pdf
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    Paper provided by University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM) in its series Discussion Papers with number 2013/07.

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    Date of creation: 2013
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    Handle: RePEc:not:notcfc:13/07
    Contact details of provider: Postal: School of Economics University of Nottingham University Park Nottingham NG7 2RD
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    Web page: http://www.nottingham.ac.uk/cfcm/index.aspx

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    1. repec:cup:cbooks:9780521806428 is not listed on IDEAS
    2. Feldstein, Martin S, 1977. "The Surprising Incidence of a Tax on Pure Rent: A New Answer to an Old Question," Journal of Political Economy, University of Chicago Press, vol. 85(2), pages 349-60, April.
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    7. Eaton, Jonathan, 1981. "Fiscal Policy, Inflation and the Accumulation of Risky Capital," Review of Economic Studies, Wiley Blackwell, vol. 48(3), pages 435-45, July.
    8. Chalk, Nigel A., 2000. "The sustainability of bond-financed deficits: An overlapping generations approach," Journal of Monetary Economics, Elsevier, vol. 45(2), pages 293-328, April.
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    10. Michael Brauninger, 2005. "The Budget Deficit, Public Debt, and Endogenous Growth," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 7(5), pages 827-840, December.
    11. Karl Farmer & Jacopo Zotti, 2010. "Sustainable government debt in a two-good, two-country overlapping generations model," International Review of Economics, Springer, vol. 57(3), pages 289-316, September.
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