Debt stabilization in a Non-Ricardian economy

Leith, C. , Moldovan, I. and Wren-Lewis, S. (2018) Debt stabilization in a Non-Ricardian economy. Macroeconomic Dynamics, 23(6), pp. 2509-2543. (doi: 10.1017/S1365100517000797)

Abstract

In models with a representative infinitely lived household, tax smoothing implies that the steady state of government debt should follow a random walk. This is unlikely to be the case in overlapping generations (OLG) economies, where the equilibrium interest rate may differ from the policy maker's rate of time preference. It may therefore be optimal to reduce debt today to reduce distortionary taxation in the future. In addition, the level of the capital stock in these economies is likely to be suboptimally low, and reducing government debt will crowd in additional capital. Using a version of the Blanchard-Yaari model of perpetual youth, with both public and private capital, we show that it is optimal in steady state for the government to hold assets. However, we also show how and why this level of government assets can fall short of both the level of debt that achieves the optimal capital stock and the level that eliminates income taxes. Finally, we compute the optimal adjustment path to this steady state.

• Item Type: Articles
• Additional Information: Leith and Wren-Lewis and grateful for financial support from the ESRC (Award No. RES-062-23-1436).
• Status: Published
• Refereed: Yes
• Glasgow Author(s) Enlighten ID: Moldovan, Dr Ioana and Leith, Professor Campbell
• Authors: Leith, C., Moldovan, I., and Wren-Lewis, S.
• College/School: College of Social Sciences > Adam Smith Business School > Economics
• Journal Name: Macroeconomic Dynamics
• Publisher: Cambridge University Press
• ISSN: 1365-1005
• ISSN (Online): 1469-8056
• Published Online: 28 June 2018
• Copyright Holders: Copyright © 2018 Cambridge University Press
• First Published: First published in Macroeconomic Dynamics 23(6):2509-2543
• Publisher Policy: Reproduced in accordance with the publisher copyright policy