Growth and Public Debt: What Are the Relevant Trade‐Offs?

• Published date: 01 March 2019
• Author: ARNAUD CHERON,KAZUO NISHIMURA,CARINE NOURRY,THOMAS SEEGMULLER,ALAIN VENDITTI
• Date: 01 March 2019
• DOI: http://doi.org/10.1111/jmcb.12543

DOI: 10.1111/jmcb.12543

ARNAUD CHERON

KAZUO NISHIMURA

CARINE NOURRY

THOMAS SEEGMULLER

ALAIN VENDITTI

Growth and Public Debt: What Are the Relevant

Trade-Offs?

The interplay between growth and public debt is addressed considering a

Barro-type (1990) endogenous growth model where public spendings are

financed through taxes on income and public debt. The government has a

target level of public debt relative to GDP, and the long-run debt-to-GDP

ratio is used as a policy parameter.We show that when debt is a large enough

proportion of GDP,two distinct balanced-growth paths (BGPs) may coexist,

one being indeterminate. Weexhibit two types of important trade-offs asso-

ciated with self-fulfilling expectations. First, we show that the lowest BGP

is always decreasing with respect to the debt-to-GDP ratio while the highest

one is increasing. Second, we show that the highest BGP,which provides the

highest welfare, is always locally indeterminate while the lowest is always

locally determinate. Therefore, local and global indeterminacy may arise

and self-fulfilling expectations appear as a crucial ingredient to understand

This work has benefited from the financial support of the French National Research Agency (ANR

n°ANR-15-CE33-0001-01), and of the Japan Society for the Promotion of Science, Grant-in-Aid for

Research #23000001 and #15H05729. We thank the Editor P.-S. Lam and two anonymous referees to-

gether with G. Bertola, R. Boucekkine, M. Devereux, F.Dufourt, M. Dupaigne, A. Eyquem, K. Gente, M.

L´

eon-Ledesma, M. Maffezzoli, X. Raurich, and M. Pifferfor useful comments and suggestions. This paper

also benefited from presentations at EDHEC Business School, October 2014, at the “Anglo-French-Italian

Macro Workshop,”AMSE-GREQAM, December 2014, at the Workshop on “Macroeconomic Challenges

in the International Economy,” AMSE-GREQAM, March 2015, at the “15th SAET Conference,” Univer-

sity of Cambridge, July 2015, at the International Conference on “Financial and Real Interdependencies:

Volatility, Inequalities and Economic Policies,” Cat´

olica Lisbon School of Business and Economics, May

2015, and at the “ASSET Meeting,” Granada, November2015.

ARNAUD CHERON is with University of Le Mans (GAINS) & EDHEC Business School (E-

mail: Arnaud.cheron@edhec.edu). KAZUO NISHIMURA is with RIEB, Kobe University (E-mail:

nishimura@kier.kyoto-u.ac.jp). CARINE NOURRYand THOMAS SEEGMULLER are with Aix-Marseille Univer-

sity, CNRS, EHESS, Centrale Marseille, AMSE, Marseille, France (E-mails: carine.nourry@univ-amu.fr

and thomas.seegmuller@univ-amu.fr). ALAIN VENDITTI is with Aix-Marseille University, CNRS, EHESS,

Centrale Marseille,AMSE, Marseille, France,and EDHEC Business School (E-mail: alain.venditti@univ-

amu.fr).

Received November 3, 2016; and accepted in revised form March 27, 2018.

Journal of Money, Credit and Banking, Vol.51, Nos. 2–3 (March–April 2019)

C

2018 The Ohio State University

656 :MONEY,CREDIT AND BANKING

the impact of debt on growth, welfare, and macroeconomic fluctuations.

Finally, a simple calibration exercise allowsto provide an understanding of

the recent experiences of many OECD countries.

JEL codes: C62, E32, H23

Keywords: endogenous growth,public spending, public debt, sunspot

fluctuations.

THE LAST FINANCIAL CRISIS HAS shed the light on the problem

of large public debt in developed countries, in particular in Europe. As a response

to the large negative shock that resulted from the drastic fall of asset prices, most

governments have increased their public spendings to support both the aggregate

demand and the production process. As a consequence, in many advanced countries,

debt levels have increased dramatically during the last decade. The control of the

growth rate of public spending has then become a major concern for economists

and policymakers while public deficits have reached unsustainable levels. Indeed,

a heavily indebted country may appear as fragile, for many reasons, among which

solvency, or simply because it is unlikely to raise sufficient funds to deal with a large

negative shock on its economy.

The Maastricht treaty introduced a rule on the maximal amount a country may

contract, limiting the debt to 60% of GDP, but over the last decade this limit has

been exceeded by most advanced countries, not only European ones, and even before

2008, as shown in Figure 1.

At the same time, most of these countries are characterized over this period by low

average growth rates and quite large fluctuations of GDP.1Given this fact, two types

of questions become central:

1. What is the relationship between debt and growth?

2. What is the relationship between macroeconomic stability and debt?

While the literature has recently focused on the first question, mainly through

empirical analyses, little attention has been paid to the second.

This paper proposes to fill this gap and to study the relationships between debt,

growth, and macroeconomic fluctuations in the simple framework of a Barro-type

(1990) endogenous growth model. Our aim is precisely to discuss the effect of

public debt on the endogenous growth rate and on fluctuations of this growth rate.

We focus on government intervention as a source of macroeconomic fluctuations

when government spendings are financed through taxes on income and public debt.

Public spending is useful because it improves, through the supply of a public good,

households’ utility of consumption and production. In order to focus on the recent

public policies, we assume, as in Minea and Villieu (2013),2that the government

gradually adjusts the debt-to-GDP ratio in order to converge toward a target level in

1. See Section 5 for illustrative data on these facts.

2. See also Futagami, Iwaisako, and Ohdoi (2008) for a similar formulation but with a public debt

target defined as a ratio to private capital.