Skip to main content
×
Home

PUBLIC DEBT AND AGGREGATE RISK

  • Audrey Desbonnet (a1) and Sumudu Kankanamge (a2)
Abstract

In this paper, we investigate the importance of aggregate fluctuations for the assessment of the optimal level of public debt in an incomplete-markets economy. We start by building a steady state model in which households are only subject to uninsurable idiosyncratic risk and evaluate the optimal level of public debt. We then augment the model to allow for aggregate risk and measure the impact on the optimal level. We show that the cyclical behavior of the economy has a quantitative impact on this level that can be decomposed into the effects of the aggregate productivity shock and the cyclicality of unemployment. Moreover, we find that matching wealth distribution statistics substantially changes the optimal level of public debt.

Copyright
Corresponding author
Address correspondence to: Sumudu Kankanamge, Toulouse School of Economics, GREMAQ–Manufacture des Tabacs, 21, allée de Brienne, 31000 Toulouse, France; e-mail: sumudu.kankanamge@tse-fr.eu.
Footnotes
Hide All

The authors wish to thank Yann Algan, Antoine d'Autume, Fabrice Collard, Wouter Den Haan, Jean-Olivier Hairault, Michel Juillard, Pierre Malgrange, Franck Portier, Gianluca Violante, Thomas Weitzenblum, the editor, William A. Barnett, the associate editor, and two anonymous referees for their helpful comments.

Footnotes
References
Hide All
Aiyagari S. (1994) Uninsured idiosyncratic risk and aggregate saving. Quarterly Journal of Economics 109 (3), 659684.
Aiyagari S., Marcet A., Sargent T., and Seppala J. (2002) Optimal taxation without state-contingent debt. Journal of Political Economy 110 (6), 12201254.
Aiyagari S.R. and McGrattan E.R. (1998) The optimum quantity of debt. Journal of Monetary Economics 42 (3), 447469.
Ball L. and Mankiw N.G. (1996) What Do Budget Deficits Do? Working paper 5263, National Bureau of Economic Research.
Barro R.J. (1979) On the determination of the public debt. Journal of Political Economy 87 (5), 940971.
Bewley T. (1986) Stationary monetary equilibrium with a continuum of independently fluctuating consumers. In Hildenbrand W. and Mas-Colell A. (eds.), Contributions to Mathematical Economics in Honor of Gerard Debreu, pp. 79102. North Holland: Elsevier.
Budria-Rodriguez S., Díaz-Giménez J., Quadrini V., and Rios-Rull J. (2002) Updated facts on the US distributions of earnings, income, and wealth. Federal Reserve Bank of Minneapolis Quarterly Review 26 (3).
Cagetti M. (2003) Wealth accumulation over the life cycle and precautionary savings. Journal of Business and Economic Statistics 21 (3), 339353.
Cagetti M. and De Nardi M. (2008) Wealth inequality: Data and models. Macroeconomic Dynamics 12 (52), 285313.
Chari V.V., Christiano L.J., and Kehoe P.J. (1994) Optimal fiscal policy in a business cycle model. Journal of Political Economy 102 (4), 617652.
De Nardi M. (2004) Wealth inequality and intergenerational links. Review of Economic Studies 71 (3), 743768.
Den Haan W. (1996) Heterogeneity, aggregate uncertainty, and the short-term interest rate. Journal of Business and Economic Statistics 14 (4), 399411.
Den Haan W.J. (1997) Solving dynamic models with aggregate shocks and heterogeneous agents. Macroeconomic Dynamics 1 (2), 355386.
Desbonnet A. and Weitzenblum T. (2012) Why do governments end up with debt? short-run effects matter. Economic Inquiry 50 (4), 905919.
Farhi E. (2010) Capital taxation and ownership when markets are incomplete. Journal of Political Economy 118 (5), 908948.
Floden M. (2001) The effectiveness of government debt and transfers as insurance. Journal of Monetary Economics 48 (1), 81108.
Floden M. and Linde J. (2001) Idiosyncratic risk in the United States and Sweden: Is there a role for government insurance? Review of Economic Dynamics 4 (2), 406437.
Fuchs-Schundeln N. and Schundeln M. (2005) Precautionary savings and self-selection: Evidence from the German reunification “experiment.” Quarterly Journal of Economics 120 (3), 10851120.
Gourinchas P. and Parker J. (2002) Consumption over the life cycle. Econometrica 70 (1), 4789.
Grechyna D. (2016) Debt and deficit fluctuations in a time-consistent setup. Macroeconomic Dynamics 20 (7), 17711794.
Hassler J., Krusell P., Storesletten K., and Zilibotti F. (2005). The dynamics of government. Journal of Monetary Economics 52 (7), 13311358.
Hassler J., Storesletten K., and Zilibotti F. (2003) The survival of the welfare state. American Economic Review 93 (1), 87112.
Heathcote J. (2005) Fiscal policy with heterogeneous agents and incomplete markets. Review of Economic Studies 72 (1), 161188.
Huggett M. (1993) The risk-free rate in heterogeneous-agent incomplete-insurance economies. Journal of Economic Dynamics and Control 17 (5–6), 953969.
Imrohoroglu A. (1989) Cost of business cycles with indivisibilities and liquidity constraints. Journal of Political Economy 97 (6), 13641383.
Klein P., Krusell P., and Rios-Rull J. (2008). Time-consistent public policy. Review of Economic Studies 75 (3), 789808.
Klein P., Quadrini V., and Rios-Rull J. (2005) Optimal time-consistent taxation with international mobility of capital. BE Journals–-Advances in Macroeconomics 5.
Klein P. and Rios-Rull J.-V. (2003) Time-consistent optimal fiscal policy. International Economic Review 44 (4), 12171245.
Krebs T. (2003) Growth and welfare effects of business cycles in economies with idiosyncratic human capital risk. Review of Economic Dynamics 6 (4), 846868.
Krusell P. (2002) Time-consistent redistribution. European Economic Review 46 (4–5), 755769.
Krusell P., Mukoyama T., Sahin A., and Smith A.A. Jr. (2009) Revisiting the welfare effects of eliminating business cycles. Review of Economic Dynamics 12 (3), 393404.
Krusell P. and Smith A. (1997) Income and wealth heterogeneity, portfolio choice, and equilibrium asset returns. Macroeconomic Dynamics 1 (2), 387422.
Krusell P. and Smith A. (1998) Income and wealth heterogeneity in the macroeconomy. Journal of Political Economy 106 (5), 867896.
Krusell P. and Smith A.A. (1999) On the welfare effects of eliminating business cycles. Review of Economic Dynamics 2 (1), 245272.
Lucas R. (1987) Models of Business Cycles. New York: Basil Blackwell.
Lucas R.E. and Stokey N.L. (1983) Optimal fiscal and monetary policy in an economy without capital. Journal of Monetary Economics 12 (1), 5593.
Mincer J. (1991) Education and Unemployment. Technical report, National Bureau of Economic Research.
Mukoyama T. and Sahin A. (2006) Costs of business cycles for unskilled workers. Journal of Monetary Economics 53 (8), 21792193.
Prescott E. (1986) Theory ahead of business cycle measurement. In Carnegie-Rochester Conference Series on Public Policy 25, 11–44.
Quadrini V. (2000) Entrepreneurship, saving, and social mobility. Review of Economic Dynamics 3 (1), 140.
Shin Y. (2006) Ramsey meets Bewley: Optimal Government Financing with Incomplete Markets. Unpublished manuscript, Washington University in St. Louis.
Storesletten K., Telmer C.I., and Yaron A. (2001) The welfare cost of business cycles revisited: Finite lives and cyclical variation in idiosyncratic risk. European Economic Review 45 (7), 13111339.
Storesletten K., Telmer C.I., and Yaron A. (2004) Cyclical dynamics in idiosyncratic labor market risk. Journal of Political Economy 112 (3), 695717.
Topel R. (1993) What have we learned from empirical studies of unemployment and turnover? American Economic Review 83 (2), 110115.
Woodford M. (1990) Public debt as private liquidity. American Economic Review 80 (2), 382388.
Recommend this journal

Email your librarian or administrator to recommend adding this journal to your organisation's collection.

Macroeconomic Dynamics
  • ISSN: 1365-1005
  • EISSN: 1469-8056
  • URL: /core/journals/macroeconomic-dynamics
Please enter your name
Please enter a valid email address
Who would you like to send this to? *
×

Keywords:

Metrics

Full text views

Total number of HTML views: 0
Total number of PDF views: 12 *
Loading metrics...

Abstract views

Total abstract views: 70 *
Loading metrics...

* Views captured on Cambridge Core between 22nd November 2017 - 12th December 2017. This data will be updated every 24 hours.