Working Paper: NBER ID: w29138
Authors: Narayana R. Kocherlakota
Abstract: This paper studies the public debt implications of a class of Aiyagari (1994)-Bewley (1977)-Huggett (1993) (ABH) models of incomplete insurance in which agents face a near-zero probability of a highly adverse outcome. In generic models of this kind, there exists a public debt bubble, so that the government is able to borrow at a real interest rate that is perpetually below the economic growth rate. Given an equilibrium with a public debt bubble, the primary deficit and the level of debt are both strictly increasing in the real interest rate and in the fraction of government expenditures used for lumpsum transfers. There is no upper bound on the deficit level or long-run debt level that is sustainable in equilibrium. In a public debt bubble, regardless of its size, agents are better off in the long run if the government chooses policies that give rise to a larger debt and primary deficit.
Keywords: No keywords provided
JEL Codes: E62; H62; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| transition probability to auxiliary state near zero (C24) | existence of a public debt bubble (H63) |
| real interest rate approaches zero (E43) | value of government debt increases (H63) |
| redistribution parameter nears one (D39) | value of government debt increases (H63) |
| real interest rate and redistribution parameter increase (E25) | size of primary deficit increases (H62) |
| real interest rate and redistribution parameter increase (E25) | level of debt increases (H63) |
| size of redistribution parameter and real interest rate increase (E43) | expected utility from private consumption increases (D11) |
| public debt bubble (H63) | level of public debt is too small (H63) |
| government increases debt and deficit (H69) | societal welfare increases (D69) |