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Alternative Perspectives on Optimal Public Debt Adjustment

  • Michal Horvath

    ()

We compare alternative optimal public debt adjustment strategies in a New Keynesian economy. We find that the unconditionally optimal policy is consistent with a gradual adjustment in public debt towards its mean value at a speed determined by the rate of time preference of agents. To a second-order approximation in a stochastic setting, debt follows a unit root process with a negative drift under the 'timeless-perspective' approach but converges to an unconditional mean different from the non-stochastic steady state in the unconditionally optimal economy. Overall, increases in public debt are shown to be optimally reduced by half only after approximately two decades at best.

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Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 200607.

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Date of creation: 15 Jun 2006
Date of revision: 15 Sep 2011
Handle: RePEc:san:cdmawp:0607
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