Public Debt and the Balance Sheet of the Private Sector
45 Pages Posted: 1 Aug 2022 Last revised: 18 Jan 2023
Date Written: July 9, 2022
Abstract
This paper studies the political and welfare determinants of fiscal policy and growth. We introduce different interest groups, firms and households, into a simple growth model with incomplete markets, heterogeneous agents, and non-insurable idiosyncratic productivity shocks. Firms finance productive investments by issuing bonds but cannot issue equity. Households invest in corporate and public debt. The government selects the levels of taxes and public debt so as to maximize a weighted sum of the welfare of firms' owners and households. More government debt reduces corporate leverage, increases the risk free rate r, and decreases the growth rate g. The weight of firms in social welfare determines whether r
Keywords: Incomplete Financial Markets, Debt, Interest, Growth, Ponzi Games, Heterogeneous Agents, Political Economy
JEL Classification: E44, E62
Suggested Citation: Suggested Citation