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

Desbonnet, Audrey; Weitzenblum, Thomas

Desbonnet, Audrey; Weitzenblum, Thomas (2012), Why do governments end up with debt ? Short-run effects matter, Economic Inquiry, 50, 4, p. 905-919. http://dx.doi.org/10.1111/j.1465-7295.2011.00410.x

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Type

Article accepté pour publication ou publié

Date

2012

Journal name

Economic Inquiry

Volume

Number

Publisher

Wiley

Pages

905-919

Abstract (EN)

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.

Subjects / Keywords

Public debt; Government Policy

JEL

E60 - General
H60 - General