Public debt and the limits of fiscal policy to increase economic growth

Vladimir Teles () and Caio Cesar Mussolini

European Economic Review, 2014, vol. 66, issue C, 1-15

Abstract: This study proposes a theoretical model of endogenous growth that demonstrates that the level of the public debt-to-gross domestic product (GDP) ratio should negatively impact the effect of fiscal policy on growth. This effect occurs because government indebtedness extracts a portion of young people's savings to pay interest on the debts. Therefore, the payment of debt interest requires an allocation exchange system across generations that is similar to a pay-as-you-go pension system, which results in changes in the savings rate of the economy. The major conclusions of the theoretical model were verified using an econometric model that provides evidence of the validity of this conclusion. Our empirical analysis controls for time-invariant, country-specific heterogeneity in growth rates. We also address endogeneity issues and allow for heterogeneity across countries in the model parameters and for cross-sectional dependence.

Keywords: Public debt; Endogenous growth; Fiscal policy (search for similar items in EconPapers)
JEL-codes: O23 O41 O54 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (101)

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Working Paper: Public debt and the limits of fiscal policy to increase economic growth (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:66:y:2014:i:c:p:1-15

DOI: 10.1016/j.euroecorev.2013.11.003

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