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DEBT STABILIZATION IN A NON-RICARDIAN ECONOMY

Published online by Cambridge University Press:  28 June 2018

Campbell Leith ,
Ioana Moldovan  and
Simon Wren-Lewis
Campbell Leith
Affiliation:
University of Glasgow
Ioana Moldovan*
Affiliation:
University of Glasgow
Simon Wren-Lewis
Affiliation:
University of Oxford
*
Address correspondence to: Ioana Moldovan, Department of Economics, Adam Smith Business School, University of Glasgow, University Avenue, Glasgow, G12 8QQ, United Kingdom; e-mail: [email protected].
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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.

Keywords

Non-Ricardian ConsumersMacroeconomic StabilityDistortionary Taxes
Type
Articles
Information
Macroeconomic Dynamics , Volume 23 , Issue 6 , September 2019 , pp. 2509 - 2543
Copyright
Copyright © Cambridge University Press 2018 

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Footnotes

Our thanks to Charles Brendon, Alfred Greiner, Tom Holden, Eric Leeper, Pei-Ju Liao, Patrick Minford, Balazs Parkanyi, Matteo Salto, Mathias Trabandt, Mike Wickens, and participants at the ASSA/AEA meetings in San Diego and seminars in Brussels, Cardiff and Oxford for helpful comments, but all responsibility remains ours. C. Leith and S. Wren-Lewis are grateful for financial support from the ESRC (Award No. RES-062-23-1436).

References

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