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Wealth inequality and the optimal level of government debt

Author

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  • Sigrid Röhrs
  • Christoph Winter

Abstract

In this paper, we quantitatively analyze to what extent a benevolent government should issue debt in a model where households are subject to idiosyncratic productivity shocks, insurance markets are missing and borrowing is restricted. In this environment, issuing government bonds facilitates saving for self-insurance. Despite this, we find that in a calibrated version of the model that is consistent with the skewed wealth and earnings distribution observable in the U.S., the government should buy private bonds, and not issue public debt in the long run. The reason is that in the U.S., a large fraction of the population has almost no wealth or is even in debt. The wealth-poor, however, do not profit from an increase in the interest rate following an increase in public debt. Instead, they gain from higher wages that result from a reduction in debt. We show that even when the short run costs of higher capital taxation are taken into account, it still pays off to reduce government debt on overall. Moreover, we find that endogenizing household’s borrowing constraints by assuming limited commitment leads to even higher asset levels being optimal in the long run.

Suggested Citation

  • Sigrid Röhrs & Christoph Winter, 2011. "Wealth inequality and the optimal level of government debt," ECON - Working Papers 051, Department of Economics - University of Zurich.
  • Handle: RePEc:zur:econwp:051
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Wealth inequality and the optimal level of government debt
      by Christian Zimmermann in NEP-DGE blog on 2012-01-07 02:43:50

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    2. Ewa Aksman, 2017. "Do Poverty and Income Inequality Affect Public Debt?," Gospodarka Narodowa. The Polish Journal of Economics, Warsaw School of Economics, issue 6, pages 79-93.
    3. Fève, Patrick & Matheron, Julien & Sahuc, Jean-Guillaume, 2012. "The Laffer Curve in an Incomplete-Market Economy," IDEI Working Papers 707, Institut d'Économie Industrielle (IDEI), Toulouse, revised Jul 2013.
    4. Vogel, Edgar, 2014. "Optimal level of government debt - matching wealth inequality and the fiscal sector," Working Paper Series 1665, European Central Bank.
    5. Vogel, Edgar, 2014. "Optimal Level of Government Debt: Matching Wealth Inequality and the Fiscal Sector," MEA discussion paper series 201410, Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy.

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    More about this item

    Keywords

    Government debt; endogenous borrowing constraints; incomplete markets; crowding out;
    All these keywords.

    JEL classification:

    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • H6 - Public Economics - - National Budget, Deficit, and Debt
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets

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