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Dynamic analysis of reductions in public debt in an endogenous growth model with public capital

  • Noritaka Maebayashi


    (Graduate School of Economics, Osaka University)

  • Takeo Hori


    (College of Economics, Aoyama Gakuin University)

  • Koichi Futagami


    (Graduate School of Economics, Osaka University)

We construct an endogenous growth model with productive public capital and government debt when government debt is adjusted to the target level. We examine how reducing public debt in an economy with a large public debt affects the transition of the economy and welfare. We find that the government faces the following trade off when reducing its debt. In the short run, public investment is reduced to decrease the debt and this has a negative effect on welfare. However, as the interest payments on the debt decrease, public investment begins to increase. Eventually, the government can increase the amount of public investment by more than before. This has a positive effect on welfare, implying that reducing the debt is welfare improving. Furthermore, we find that the adjustment speed of reductions in debt affects welfare crucially. The relationships between the welfare gains and the adjustment speed are U-shaped in many cases. However, they are decreasing monotonically when the tax rate is low and the initial debt?GDP ratio is sufficiently large.

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Paper provided by Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP) in its series Discussion Papers in Economics and Business with number 12-08.

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Length: 36 pages
Date of creation: Apr 2012
Date of revision:
Handle: RePEc:osk:wpaper:1208
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