WHY DO GOVERNMENTS END UP WITH DEBT? SHORT‐RUN EFFECTS MATTER |
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| Authors: | AUDREY DESBONNET THOMAS WEITZENBLUM |
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| Institution: | Desbonnet: Assistant Professor, University Paris‐Dauphine, LEDa, Place du Maréchal de Lattre de Tassigny, 75775 Paris Cedex 16, France. Phone +33 (0) 1 44 05 45 29, E‐mail audrey.desbonnet@dauphine.fr |
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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. (JEL E60, H60) |
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