Working Paper: CEPR ID: DP15950
Authors: Ricardo Reis
Abstract: With real interest rates below the growth rate of the economy, but the marginal product of capital above it, the public debt can be lower than the present value of primary surpluses because of a bubble premia on the debt. The government can run a deficit forever. In a model that endogenizes the bubble premium as arising from the safety and liquidity of public debt, more government spending requires a larger bubble premium, but because people want to hold less debt, there is an upper limit on spending. Inflation reduces the fiscal space, financial repression increases it, and redistribution of wealth or income taxation have an unconventional effect on fiscal capacity through the bubble premium.
Keywords: debt limits; debt sustainability; incomplete markets; misallocation
JEL Codes: D52; E62; G10; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| real interest rate (r) (E43) | public debt (H63) |
| growth rate (g) (O40) | public debt (H63) |
| marginal product of capital (m) (E22) | public debt (H63) |
| government spending (H59) | bubble premium (E32) |
| inflation (E31) | fiscal space (E62) |
| financial repression (G28) | fiscal space (E62) |