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Debt stabilization in a Non-Ricardian economy

Campbell Leith (), Ioana Moldovan () and Simon Wren-Lewis ()

Working Papers from Business School - Economics, University of Glasgow

Abstract: In models with a representative infinitely lived household, modern versions of tax smoothing imply that the steady-state of government debt should follow a random walk. This is unlikely to be the case in OLG economies, where, the equilibrium interest rate may differ from the policy-maker’s rate of time preference such that it may be optimal to reduce debt today to reduce distortionary taxation in the future. Moreover, the level of the capital stock (and therefore output and, possibly, consumption) in these economies is likely to be sub-optimally low, and reducing government debt will ‘crowd in’ additional capital. Using an elaborate version of the model of perpetual youth developed by Blanchard (1985) and Yaari (1965), we derive the optimal steady state level of government assets. We show how and why this level of government assets falls short of the level of debt that achieves the optimal capital stock and the level that eliminates income taxes.

Keywords: Non-Ricardian consumers; macroeconomic stability; distortionary taxes (search for similar items in EconPapers)
JEL-codes: E21 E32 E63 (search for similar items in EconPapers)
Date: 2011-10
New Economics Papers: this item is included in nep-dge and nep-mac
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Related works:
Journal Article: DEBT STABILIZATION IN A NON-RICARDIAN ECONOMY (2019) Downloads
Working Paper: Debt Stabilization in a Non-Ricardian Economy (2011) Downloads
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