Why do governments end up with debt ? Short-run effects matter

Audrey Desbonnet () and Thomas Weitzenblum ()
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Audrey Desbonnet: LEDa - Laboratoire d'Economie de Dauphine - IRD - Institut de Recherche pour le Développement - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique
Thomas Weitzenblum: EQUIPPE - Economie Quantitative, Intégration, Politiques Publiques et Econométrie - Université de Lille, Sciences et Technologies - Université de Lille, Sciences Humaines et Sociales - PRES Université Lille Nord de France - Université de Lille, Droit et Santé

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Abstract: This paper reconsiders the impact of public debt in an economy with heterogeneous households and incomplete markets to emphasize the short-run effects of an increase in public debt. As compared to models that rest on steady-state analysis, we show that the welfare gains of a public debt increase are substantially higher when transitional dynamics are accounted for. The additional debt issue allows for a temporary reduction in the income tax rate, which stimulates labor supply and generates an overshooting of the interest rate. The short-run gains create a temptation to deviate toward higher levels of debt. Debt increases continue to generate welfare gains even when debt is considerably higher than its long-run optimal level.

Keywords: Government Policy; Public debt (search for similar items in EconPapers)
Date: 2012
Note: View the original document on HAL open archive server: https://hal.science/hal-01518357v1
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Citations: View citations in EconPapers (8)

Published in Economic Inquiry, 2012, 50 (4), pp.905-919. ⟨10.1111/j.1465-7295.2011.00410.x⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-01518357

DOI: 10.1111/j.1465-7295.2011.00410.x

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